There are many entity formats to choose from but two of the most common entities witnessed by business attorneys are a limited liability company and an S Corporation. These two entities can be treated quite similarly and quite differently depending upon the overall circumstances. The outline below has been drafted by a Denver business attorney at The McGuire Law Firm to help outline common questions and issues our clients have. Please note there are many issues to compare between an LLC and an S Corporation, but those stated below are common issues to new businesses and small businesses.
I. Liability of Owners
A. LLC: A member’s liability is limited to the amount of their contribution unless a member has guaranteed a debt of the LLC.
B. S Corporation: Shareholders are generally not liable for any debts of a corporation, thus liability is limited unless loans or notes have been guaranteed by a shareholder.
II. Tax Elections
A. LLC: An LLC can make the election to be taxed as an S Corporation. Please note a single member LLC is considered a disregarded entity by the IRS and thus would file a Schedule C like a sole proprietor would.
B. S Corporation: A corporation makes the election to be taxed as an S Corporation. Thus, the entity is filed as a corporation with the secretary of state and then the election to be taxed as an S Corporation is made.
C. Deadline for S Election: Generally March 15th of the year in which the entity wishes to be taxed as an S Corporation.
III. Formation of Entity- Interest Received in Exchange for Property
A. LLC: Generally there is no recognition of gain for property received by the LLC in exchange for a partnership interest. See IRC 721.
B. S Corporation: Non-recognition treatment applies if the 80% control test applies- see I.R.C Section 351.
IV. Tax Returns & Extensions
A. LLC: Form 1065 is required to be filed by April 15th and an automatic 6 month extension is available.
B. S Corporation Form 1120S is required to be filed by March 15th and an automatic 6 month extension is available.
V. Who is Taxed on Income?
A. LLC: Partners are taxed on their income regardless of distributions. Losses may be deducted by partners to the extent of their basis, or a loss may be able to be deducted if the partner has agreed to a deficit restoration obligation.
B. S Corporation: Shareholders are taxed on their share of income whether or not distributed. Losses can be deducted by shareholders to the extent of their basis in the stock, plus monies loaned to the corporation.
VI. Allocation of Income & Deductions
A. LLC: In accordance with the partnership agreement (operating agreement) given there is substantial economic effect. If not, amounts are allocated per the members/partner’s interest in the partnership.
B. S Corporation: Determined pro rata based upon stock ownership.
VII. Basis Adjustments
A. LLC: Basis is increased by gains and decreased by losses. The distribution of cash or property to a member/partner and any relief of liabilities decrease basis.
B: S Corporation: Basis is increased by income and decreased by losses. Like an LLC, the distribution of money or property will decrease basis.
VIII. Salaries Paid to Owners
A. LLC: “Salaries” would qualify as guaranteed payments to members/partners and these amounts are considered self employment income.
B. S Corporation: Salaries are taxable to shareholders and deductible by the corporation. Salaries are considered self employment income.
i. Salaries to officers/shareholders create the requirement to file quarterly 941 tax returns and make federal tax deposits. Quarterly returns are due 4/30, 7/31, 10/31 and 1/31 (following year). The timing requirements for federal tax deposits depend upon the amount of withholding tax due by the entity, but generally are due when the return is filed, on the 15th of each month for the following month or within a few days of making payroll.
IX. Reasonable Compensation Limits
A. LLC: Generally, there is no reasonable compensation limit.
B. S Corporation: Officers and shareholders must receive reasonable compensation. Compensation should not be avoided by making distributions in lieu of compensation (wages/salary- subject to self-employment taxes).
If you have questions regarding the formation or taxation of a business entity, a Denver business attorney or tax attorney at The McGuire Law Firm can assist you. Call today to schedule an appointment with a business attorney.