Making Sense of the LLC vs. S Corporation Question
People regularly ask the LLC vs. S corporation question. And we're going to talk about this whole subject in detail for a few paragraphs. But let us, just in case you're in a hurry, give you the quick and dirty answer: If you're asking this question, the correct answer, nearly always, is "go with a limited liability company, or LLC".
Why an LLC is Almost Always Best
We suggest you choose an LLC if you're asking the LLC vs. S corp question for a simple reason. An LLC can elect to be treated for tax purposes as an S corporation. In other words, you can set up an LLC for your new venture and, simply by filing a three-page Form 2553 with the IRS, gain Subchapter S tax accounting treatment.
You don't, in other words, need to set up a corporation in order to get an S corporation. You just need to have something (a corporation, an LLC or some other type of entity) that the Internal Revenue Service allows to use the Subchapter S tax accounting rules and procedures.
The First Real Question is Actually LLC vs. Corporation
Can we go slightly off tangent here? The LLC vs. S corporation question should really be replaced with two other questions that actually do make sense. The first question is whether you should choose a regular corporation or a limited liability company.
And we think, for reasons that we go into in more detail in the FAQ articles, you do want to pick an LLC rather than a corporation. An LLC is akin to a "lite" corporation but without all the extra calories. Sort of like "lite beer" or "lite salad dressing". An LLC gives you all the same legal liability protection that a regular corporation does, only with less administrative overhead and fiddling.
The Second Real Question is Whether to Elect Sub S Status
By the way, the second question you want to answer (and a question you want to answer for either an LLC or a corporation) is whether you want to make a Subchapter S election for the new corporation or for the new LLC.
If you make a Subchapter S election for an LLC or corporation, you use a set of partnership-like tax accounting rules. These rules mean the business (the LLC or corporation) typically avoids corporate taxes but instead forces its owners to pay the taxes. And these rules also often mean that working business owners avoid payroll taxes (Social Security, Medicare, and self-employment taxes) on their shares of the business' profits.
Tip: For a more detailed discussion of how an S corporation saves you taxes, refer to the S corporation benefits article.
Some Other Things to Think About
Since we're talking about the whole choice of entity thing here, can we bring up some related issues? We won't take a bunch of time on this stuff. But we want to give you some other bits of information about all this.
Here's our first point. Some people just plain want to be treated as corporations. In other words, they want their business to be a corporation for almost emotional or psychological reasons. We think, if you're in this boat, that going with a traditional, "regular" corporation is fine. Hey, you're starting a business because you get to make decisions like this, right? (You will have a wee bit of extra fiddling and faddling to do in this case. But it won't be that big a deal.)
Here's a second bit of information that could be relevant to a small percentage of website visitors. If you are likely to try and someday sell interests in the business to the public in something like an initial public offering, you probably don't want to use an LLC. You instead want to use a regular corporation. Probably a Delaware corporation. By the way, if this is the case, you're probably working with a large local law firm. And you can and should get the details on why this is the case from them.
And now a third final, tangential bit of information. If you are planning to make an S election for an LLC, you may not want to make the S election effective on the LLC formation date. In other words, if you form an LLC mid-year, you may want to wait until the start of the new year or even the start of the second new year to make the S election. This will delay the point at which you begin using the S corporation tax accounting rules. So that's bad in a sense. But for very small and very new businesses, the LLC's default tax accounting rules are often easier and lower cost. You will by accepting the default rules make your accounting less expensive and easier.
Note: A single-member, or one-owner, LLC is treated for tax purposes as a sole proprietorship if it hasn't made an election to be treated as a corporation. Sole proprietorship tax treatment is usually pretty simple. And it's also often very economical for small startup firms. A multiple-member LLC, by the way, is treated for tax purposes as a partnership if it hasn't made an election to be treated as a corporation.
Additional Information You May Find Useful
If you want additional information about how to maximize the tax savings related to running a business or investment venture, you may also be interested in one of our downloadable e-books (see descriptions below). Each book covers a category of tax planning topics that easily save a business owner significant amounts of income or self-employment taxes (potentially thousands of dollars a year) and is instantly downloadable.
One of the most powerful tactics for saving small business taxes is maximizing your deductions. You can literally save thousands in taxes each year.Read More
Using an S corporation for your business? To maximize savings, you need to minimize the salary paid to shareholders. But this decision is tricky.Read More
Tax laws provide active real estate investors with giant tax planning loopholes. A little upfront planning on your part could save you thousands a year...Read More