Business structures 101

From Mark Patton, Tucson, Arizona

Jake,

You nailed exactly what I am talking about. There are certainly benefits and potential tax savings with using an S corp or a more complex structure. However, those benefits are not always worth the extra adminstrative burden that they require. Some people don't mind the extra work to save paying Uncle Sam a few bucks. Some don't think it is worth the hassle. This is why it is important for every small business owner to work with an accountant or a lawyer who can help them assess their own situation, including the potential tax savings, and then make an educated decision.

From Mark Patton, Tucson, Arizona

With all due respect Christopher, your comment is incorrect. An LLC offers the same liability protection that a corporation does. There certainly are other benefits to using an S corp over an LLC, the biggest being the potential self employment tax savings that others have discussed below, but there is no difference in liability protection.

What you may be thinking of is the difference between personal liability and company liability. For example, if your company obtains a loan and is unable to pay that back, the owners of the company have no liability unless they have personally guaranteed the loan. That is true for an LLC or a corporation. On the other hand, if an owner of a business commits fraud, the owner will probably be liable for the fraud regardless of whether the company is organized as corporation or LLC. There are, of course, a million variables and different ways to analyze the liability question, but from a liability stand point, an LLC offers the same protection as a corporation.

You may also be thinking about a limited liability partnership or professional corporation, where a partner/shareholder is not liable for the acts of another partner/shareholder, but is liable for his or her own acts. Accounting firms and law firms are often organized as LLPs or professional corporations. Many states only permit licensed professionals such as lawyers and accountants to use the LLP or PC form of business because the state doesn't want them to be able to avoid liability for their own negligence or wrongful acts.

From Christopher J Kuhnert

Hello the person that wrote this need to go back to school. If a sole proprietor then a LLC does nothing for you because you still bear 100% liability. LLC and LLP are designed if you have partners and need to list what percentage of the business you’re responsible for. The only way a sole person this going to be personally safe is to create a Corporation and file S-Corp status. S-Corp so they don’t get taxed twice.

LLC- Partnerships Limit Liability to what is in the agreement but profits are tax at individual rate
Corporation- Full Legal protection only the company can be sued. But profits might be taxed twice
Sub Chapter S ( S-Corp) the only option for a sole proprietorship to be legally protected.

From Jake, Centreville, VA

If you are a one person company, to me the biggest difference and benefit of an LLC over an S-corp is the ability to pay yourself without the hassle of setting up payroll taxes (fica,etc..). With an LLC you merely cut yourself a check and then report the income on your personal return as sole propriorship.

From Geraldo Lopez, San Francisco, CA

Can somebody elaborate on the LLC S-Election option that supposedly allows the LLC members to avoid SE taxation above and beyond their "guaranteed payments," and then take the rest as a distribution that is not subject to SE tax.

From Don R

Just a note about the significant opportunity that exists only for a S-corp. that has ONE shareholder, which is an ESOP trust. Though this ownership structure is not for everyone, it does offer tremendous tax savings opportunities compared to any other structure. a 100% ESOP-owned S-Corp. pay ZERO income taxes. That's right, nada.
Taxes are eventually paid when either an existing employee retires and receives his qualified distribution from the ESOP Trust or terminates his employment in another fashion, thus receiving a payout (should he choose not to rollover the payout into an IRA).
Congress put this special provision into place to promote employee ownership on a much broader scale. It's a great tool if the culture of the Company is conducive to it, as well as the mindset of the present owners.

From Phillip A. Staden, CPA, Staden & Co.

The story was incomplete in that there was no discussion of how payroll taxes for owners can affect the decision. LLC net income is subject to self-employment taxes, the same is not true for S-corp net income.

From Mark Patton, Tucson, Arizona

It is good to see some comments on the article. I generally agree with most of the comments here. However, the purpose of the article, as the title indicates, was a very basic introduction to what entities are appropriate for small business owners. I stand by my recommendations for the typical small business owner (small being the operative word) and point out that the article says that business owners should consult with their advisors to see if they can benefit from another structure.

There are certainly benefits to using other structures. However, again focusing on small business owners, I question whether most small business owners will be willing to use the relatively complex structures proposed below for the tax savings that are available. To truly take advantage of these the business owner must have two separate bank accounts, two complete separate sets of accounting records, file two tax returns and truly respect the separate forms of businesses among other things. If not, the IRS, creditors and courts may disregard the whole thing anyway. And that doesn't even take into account the additional professional fees incurred up front to properly set up and document the organizations which could easily exceed $10,000 plus the ongoing professional fees required to maintain the structure.

From Jim Franceus, CFP

An LLC is great for real estate and has some advantages as a holding company, but for a profit generating small business is not a very good operating entity. I would choose an "S" Corp first, and minimize self-employment tax by taking distributions of up to 50% on the first $102,000 of earned income. I would then combine it with a "C" Corp management company to use the flexibility of another fiscal year that's not calendar and also take advantage of the first $50,000 in a "C" which is taxed at 15%. There are several ways to get money out of the "C" including fringe benefits for the owner(s), loans for the business or simply paying for some non-deductible business expenses at the lower rate.

While more complex, the combination of the S,C and LLC together for operations, fringes and protection of the real estate is a winning combination from a tax point of view

From J D Phillips, Lexington, SC

Other than the possibility of going public, are there any other circumstances under which you should file as a C corp?

From Kathleen Taff

I am involved in a Family LLC and most of the members are not happy. There is only one family member named as the General Manager and she have all the control. We want out but since the Agreement was written in a way that we would lose a lot a money we are stuck. Any suggestions on how to end a LLC?

Thanks

From John E. Hill, RFP – Houston TX

I believe that pursuant to curreent tax law, the advice given regarding LLC's is not the best counsel, as well. My personal opinion is that dual entity structure is the better route. Based on tax law, a Limited Partnership should be managed by a Limited Liability Company opting to be taxed as a C-Corporation under the "check the box" rules afforded LLC's. By having the LLC manage the LP, management fees can be paid to the LLC, and the "owners" are then paid a salary through the LLC. This also serves as a way to mitigate the IRS from recharacterizing income to the LP as "guaranteed payments", which are taxed as self-employment income. Additionally, the LLC can set up an IRC Sec 105 Medical Expense Reimbursement Plan, allowing the owners to be reimbursed from a tax free perspective the uninsured medical expenses they incur. Another benefit is a deminimis expense known as a "parking allowance". In IRS Publication 15b, an owner (or other employee) can be paid $220 per month tax free for parking and toll allowance. This can be done, for example, with a husband and wife team, giving them approximately $5200 per year tax free. Yet another benefit of this structure is that an auto allowance and home office allowance can be taken from the LP. The final benefit is that both the LP and the LLC have what is known as a "charging order" provision. This makes it highly unpalatable for a suit to be filed against an LP because if the plaintiff actually wins, typically a judge can only award a charging order against distributions of profits. The IRS views an awarded charging order as income to the plaintiff having been constructively received (even though not actually received because the LLC General Partner decides NOT to distribute any profits). If the charging order "distribution" is contructively received (actually awarded to a plaintiff), then the plaintiff must pay taxes on money not actually received though constructively received. This is known as "phantom" income…making it much more likely that a potential plaintiff will be far more likely to settle as opposed to litigating. There are other benefits to this type of structure, even from a retirement planning prespective, but for now I digress!
John E. Hill, RFP
The PlanSource, L.P.
Houston, Texas

From Tom Cervantez, San Francisco CA

I think the blanket comment that LLC is the best choice is not the best counsel. LLCs cause more accounting headache – requiring annual k1 filings to the members. There is also no mention of the problem with granting stock options in LLCs – which is problematic and very simple to do in C-corp and S-corp structures. Also, at least in Silicon Valley and for most of the venture capital world – an LLC can't be invested in by most VC investors – VC funds generally are not allowed to have operating income from the portfolio companies. So – for high tech deals at least and Internet startups hoping to be acquired, you would probably be best to go for the C-corporation. The best advice is to talk to a business lawyer, tell them your goals, and then reach a decision as to what form of structure is best suited for your goals.