Forum Overview :: Tansin A. Darcos's Alter Ego :: S Corporation versus Limited Liability Company (S corp vs. LLC)

[quote name="Commander Tansin A. Darcos"]In the United States, one of the methods of legal tax avoidance (as opposed to illegal tax evasion) is for someone operating a business or other money-making operation (or asset owner) is to incorporate. it's also useful if your business might have financial woes, because if you are sued as a sole proprietor, if the other side wins, they can come after you for everything you own; if you have an entity with separate legal existence from you (like a corporation or limited partnership where you are not the general partner), you as the owner of a business operated by an entity are not liable for debts of the separate entity; they can't take your house because the business has been sued for one of your employees damaging someone's brand-new McLaren and you have inadequate (or no) insurance. The problem with operating a business as a corporation is that corporations are subject to "double taxation." First, the corporation is taxed on its income, then any dividends paid from its after-tax profit are taxed to the owner as income. Now, if your business just makes enough to pay your salary, this doesn't matter. If your corporation allows you to make more than a salary, or you want to receive the income but not pay Social Security taxes on it (wage income is subject to a 7.5% employer-paid tax and 7.5% employee-paid tax plus medicare tax of 1% (plus possibly state taxes California has automatic Disability insurance, which employers pay in additional wage tax), in addition to regular income tax; dividends are not subject to this 16% Social Security tax), then you might not want to pay the extra tax either as corporate income tax or Social Security taxes. Now, until 1977, the only way to get around this was to form an S Corporation. The corporation has to choose S option at the time of its forming by stating it is an S corporation in its chartering documents; if not, it is a standard C corporation and subject to higher C corporation taxation. An S corp also has to inform the IRS of its choice to be an S corp. There are restrictions on S corporations, they have a limit of the number of stockholders, they have to be U.S. citizens, and certain types of corporations or certain businesses cannot be S corporations. In 1977, a group of investors in an oil company convinced the Wyoming state legislature to establish the Limited Liability Company. It is not a corporation, it is more like a partnership with limited liability. In fact, today, under federal law, unless an LLC with more than one member elects to be taxed as a corporation, it is taxed as a partnership. The LLC is a copy of a much older (1892) German type of organization "<i>Gesellschaft mit beschränkter Haftung</i>" or GmbH, which translates as "limited liability company." The LLC has the benefit for a business owned by more than one person that it operates like a partnership but with the limited liability of a corporation. But, for an LLC with only one member (the owners of an LLC are not "stockholders" - as LLCs cannot issue stock - but "members") the LLC is not taxed <i>at all</i>. The single-member LLC is considered a "disregarded entity" for tax purposes. Since distributions from an LLC are not wages, they are not subject to Social Security and Medicare taxes, and since a single-member LLC is a "disregarded entity," it is not taxed on its income. There are no federal restrictions on what types of business an LLC may engage in, nor do members have to be US citizens. Thus, I think the S corporation has outlived its purposes, and unless the state you're in does not allow your business to be conducted by an LLC (some states either prohibit or have not authorized banks or insurance companies to be LLCs, and some may not allow the practice of a licensed profession such as physician or attorney to be practiced by an LLC), I suspect the S corporation to all but disappear for small businesses, as the LLC provides more flexibility, requires less formal procedures and simpler paperwork than an S or C corporation, and has fewer restrictions. Also, a few places (Canada being one) do not have the option of forming LLCs, you can only form corporations. [/quote]