12 Feb Starting A Business
WHAT ARE THE ADVANTAGES OF A LIMITED LIABILITY COMPANY OVER AN S CORPORATION?
Limited Liability Companies (LLCs) have exploded in popularity recently, even though they’ve been in existence for only ten years in California. In my own practice, clients are more inclined to form LLCs than S corporations. Why the new fad? Well, lots of reasons. But, before I explain, here is some background on an S Corporation.
The California legislature created an act known as the Corporations Code, which governs the regulation and operation of corporations. An S corporation simply means that a company is choosing to organize under the Corporations Code while making an election with the IRS to be taxed as a small business (i.e. the “S” election). The California legislature seemed to respond to the demands of many business people after they complained that corporate rules were too unwieldy and burdensome. For example, these entrepreneurs were forced to hold board meetings and elect officers. Nobody wanted to bother with these tiresome formalities. Well, Sacramento listened and enacted the Limited Liability Company Act. Nowhere will you find a requirement to hold board meetings or elect officers in the LLC statute. Nor will you find rules regarding treasury stock and redemption buy-backs. These requirements for corporations have simply disappeared. That’s not to say that LLCs are simplistic. In fact, the tax laws affecting LLCs can be quite confusing.
While LLCs may be more flexible an easier to use than S corporations, they’re not always cheaper. LLCs’ profits are subject to the self-employment tax while S corporation profits aren’t. For example, if both an LLC and an S corporation generate a $100,000 profit, the LLC will pay an extra $6,350 a year in tax. Are there ways to get around this? Yes, but it requires some imagination and risk. The LLC could make an election to be treated as a corporation for income tax purposes only and, as a result, mirror an S corporation’s taxing structure, effectively having the best of both worlds…flexibility and preferential tax treatment. This result, seemingly unfair to the IRS, may garner more scrutiny in the near future.
Some other advantages to an LLC over S corporation: 1) LLCs can have C Corporations and Partnerships as shareholders; and 2) No 3 1/3 % withholding on sale of real property (real estate brokers can relate to this one). So which is better? It really does depend on each business.