Tax Advantages of an S Corporation over a Limited Liability Company (LLC) S Corporation Limited Liability Company (LLC) 1. Corporate net income is not subject to FICA taxes. Net earnings attributable to “active” members is subject to FICA. Net income of “passive” members is not. 2. Corporate net income is not subject to Philadelphia net Net income is subject to Philadelphia net profits and profits or other local earned income taxes. other local earned income taxes. 3. Retirement plan contributions are tax-deferred for federal Retirement plan contributions are tax-deferred for federal income tax purposes and deductible for FICA, state and income tax purposes only. They are NOT deductible for local purposes. FICA, state or local purposes. 4. Health insurance premiums paid on behalf of Health insurance premiums paid on behalf of “active” shareholders are exempt from FICA taxes. members are NOT exempt from FICA taxes. 5. Loss on disposition of “S” corp stock may qualify for Loss on disposition of LLC interest does not qualify for Sec. 1244 treatment (i.e. not subject to capital loss Sec. 1244 treatment. limitations). 6. Gain on disposition of “S” corp stock may qualify for Gain on disposition of LLC interest does not qualify for Sec. 1202 exclusion (Qualified Small Business Stock). Sec. 1202 exclusion. 7. Professional practices (i.e. doctors, lawyers, CPAs, etc.) Professional practices must file an annual registration have no annual PA Dept. of State registration with PA Dept. of State and pay $360 per member annual requirement or fee. fee. 8. Flexible restructuring and merger rules. Can convert Conversions from LLC to corporate form, or visa versa from “C” to “S” and back, or merge into another are generally taxable. corporation or “go public” on a tax-free basis. 9. There is a lot of tax law and tax court history with S There is very little tax law and tax court history with corporations LLCs Tax Advantages of an LLC over an S Corporation Limited Liability Company (LLC) 1. Considered to be easier to set up and operate. 2. 3. May have unlimited members. Lenient member qualifications. There are no restrictions on eligibility for LLC membership. May have multiple classes of ownership interest. Special allocations of income, deductions, gain and loss items between members are permissible. LLC borrowings increase the basis of the LLC’s “active” membership, making losses easier to deduct. This higher basis may also make distributing refinancing proceeds less taxing. An LLC may elect to step up the basis of its assets upon the death of a member or the sale of a membership interest (IRC Sec. 754). An LLC is not subject to built-in gains tax or excess passive income tax. Members can receive distributions free of tax withholding, but must make quarterly estimated tax payments to IRS and state. There will be some social security tax savings if an “active” LLC member has a separate source of W-2 income and will hit the social security tax threshold ($90,000 in 2005). The member will escape both halves of the social security tax on all excess earnings.
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S Corporation Not quite as easy. Timely elections must be filed, annual meetings and minutes required, etc. May only have up to 100 shareholders. Corporations, LLCs, partnerships, non-resident aliens and most types of trusts cannot be shareholders of an S corporation. May only have one class of stock. Allocations of income, deductions, gain and loss items are reportable to shareholders on a per-share, per-day basis. Shareholders may not increase the basis of their stock when the corporation borrows money or when a shareholder guarantees a corporate loan. Distributions of refinancing proceeds will be taxable to the extent they exceed the shareholders’ basis. An S corporation may not adjust the basis of its assets upon the death of a shareholder or the sale of stock by the shareholder. S corporations with prior C corp earnings and profits may be subject to built in gains tax and excess passive income tax. Shareholder is generally considered an employee of the company and receives compensation via a W-2, with appropriate tax withholdings. Since a shareholder is considered an employee, the corporation will have to withhold and match the social security tax (6.2% + 6.2% = 12.4%). The shareholder may claim a refund of social security tax paid on the excess earnings. The corporation cannot.