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EDIT: be sure to check out LH2004's corrections to the piece referenced below.

I'm prepping end of year tax positioning, and came across this piece. It explains that a multiple-person owned LLC can opt to be taxed like an s-corp. [Q]For individual business owners, the LLC offers a one-person LLC form, which is taxed as a sole proprietorship. In addition to offering the owner all-important limited personal liability exposure, the LLC retains important tax benefits of the sole proprietorship, such as: owner compensation in the form of distributions of profit, which are taxed at the individual owner's potentially lower marginal tax bracket (the tax rate applicable to the next dollar of taxable income the owner earns); and pass-through of business losses, offsetting the owner's other non business income.

For businesses with multiple owners, the LLC form offers similar tax benefits, plus the added advantages of a corporate form. If the owners or members of an LLC do nothing, their LLC will be taxed as a partnership; however, they can elect for their LLC to be taxed as a corporate entity—typically the preferred option. And within that option is another option to elect to be taxed as either an S or a C corporation.This is news to me. But the IRS confirms it also.

This seems to open up all kinds of possibilities. Basically, two or more people can get all the tax benefits of an S-corp (which can considerable, especially if we're talking about earned income), without going through the hassle of most corporate formalities.

If you've investigated this, done it, or have questions about it, please post here. If you're more generally interested in exploiting tax treatment of an LLC proper, you might check out this FW Finance thread.


[Edited title to remove incorrect reference to multiple-owner LLCs.]

An LLC need not have multiple members to be treated as a corporation. Any entity other than a "per se corporation" can "check the box" to be treated as a corporation if it wants to (except that, in the case of certain foreign entities, they are treated as corporations unless they "check the box" not to be treated as a corporation). The regs are completely unambiguous about this.

You don't even need to have an LLC for this purpose. A common law partnership requires no filings at all to form (though it doesn't give liability protection), and, provided it has multiple members, could elect to be taxed as a corporation.

I agree that it is generally preferable to use an LLC rather than a state-law corporation, no matter what tax status you want.

What, exactly, are the tax benefits you expect to get from an S corporation that you couldn't get from an LLC taxed as a partnership or disregarded entity? There are lots of disadvantages (including the risk you will accidentally become a C corporation), and very few advantages.

We do this for clients all the time. An L.L.C. is not a tax status but a state law entity. OP is correct in that you get rid of a lot of the state law corporate formalities by going this route. You may also be able to get rid of Franchise taxes (depending on the state) by doing an F-reorganization and merging an existing C/S corp into a newly formed L.L.C.

WARNING!
Before doing this, make sure you consult an attorney. Different businesses have different licensing requirements (check federal, state and local). For example: medicare/medicaid may view this as a Change of Ownership (CHOW) and you would have to go through any licensing/application process from scratch. This is both time consuming and expensive, thereby outweighing any savings.

DaveHanson said: [Q]I'm prepping end of year tax positioning, and came across this piece.
Please, do not believe much of what you read on this page. It is based on the state of the law as of no more recently than 1997, and the author misunderstands even what the law was then.

Among the errors:
An LLC need not have multiple owners to be a corporation for tax purposes.
An LLC taxed as an S corporation may NOT have more than 75 shareholders.
An LLC taxed as an S corporation may NOT have a nonresident alien shareholder.
An LLC taxed as an S corporation may have "disproportionate" ownership in the sense that ownership is not proportional to investment, but so may absolutely any other entity. An LLC taxed as an S corporation may NOT distribute different kinds of taxable income in different proportions.
An LLC taxed as an S corporation may NOT "flow through" losses in excess of shareholders' basis (which does not include indebtedness, in the case of an S corporation).
An LLC taxed as an S corporation may own more than 80% of another corporation, but so may any other S corporation (or any other entity).
It is NOT generally preferable for an LLC holding a newly-formed business to elect to be taxed as an S corporation. C corporation status will make sense in limited cases; otherwise, multiple-member LLC's should almost always prefer partnership status.

I am really confused.

According to the article,
"With the advent of the LLC form, business owners can now enjoy protection from any present and future liabilities or judgments against the business without having to incorporate."

Is this means that you can get a LLC without incorporate(without filing paper work with state)?


Big thanks to LH2004 and mt for responding so rapidly and on-point.

LH2004 wrote, [Q]Any entity other than a "per se corporation" can "check the box" to be treated as a corporation if it wants to ...The regs are completely unambiguous about this.I did not know this. Is this a recent change? I wonder why it's so often stated that one would incorporate (as opposed to doing an LLC) to reduce the SS tax hit, if this isn't even necessary...

Would you be able to refer me to an IRS reg or publication that speaks to this? Not questioning your accuracy, just want to do some DD.[Q]What, exactly, are the tax benefits you expect to get from an S corporation that you couldn't get from an LLC taxed as a partnership or disregarded entity? There are lots of disadvantages (including the risk you will accidentally become a C corporation), and very few advantages. A very good question. Here are two possible tax reasons, (please correct any assumptions you know or thing might be wrong:

-Our 2 S-corps have only spouse and myself as owners. Hence I didn't think we could qualify as "multiple members," being one filer for tax purposes (assuming this would be right)? So to get s-corp tax status, we would need to be an actual S-corp. Your next post did say, "An LLC need not have multiple owners to be a corporation for tax purposes." And, re-reading my IRS link above, it does say that is will be treated as a sole proprietorship "unless an election is made to be treated as a corporation" via form 1120, which confirms that. So, I seem to have been misinformed there.

-Since we're both officers, then meetings, trips, even lunches where we do bona-fide business qualify as valid business expenses and are therefore deductible. (Since LLCs don't have a corporate structure, my understanding is that there'd be less room for legitimately doing this there.)

And non-tax related reasons:

-We want to establish non-"personal guaranteed"-based business credit. I've been told that true incorporation can add credibility in these efforts.

-Expenses here in WA are very reasonable, making it less of a issue than elsewhere. $195 to file, $59 a year, can all be done online and approved immediately (which isn't true of LLCs, though this will change next year.) Of course this is less a reason TO pick it over an LLC than it is not to shy away from it.


I would be most interested in hearing more (links and references would be great also) about the "lots of disadvantages...and very few advantages" of s-corps over LLCs. I've actually done a fair bit of reading on the subject, but clearly I'm not as informed as I should be.
[Q] An LLC taxed as an S corporation may NOT distribute different kinds of taxable income in different proportions."different kinds" meaning what here? [Q]It is NOT generally preferable for an LLC holding a newly-formed business to elect to be taxed as an S corporation. C corporation status will make sense in limited cases; otherwise, multiple-member LLC's should almost always prefer partnership status. Could you elaborate, or provide links/references that do so? TIA!


swangd, you have to file paperwork to get an LLC, but technically you're not incorporating.

DaveHanson said: [Q]Big thanks to LH2004 and mt for responding so rapidly and on-point.

LH2004 wrote, [Q]Any entity other than a "per se corporation" can "check the box" to be treated as a corporation if it wants to ...The regs are completely unambiguous about this.I did not know this. Is this a recent change? I wonder why it's so often stated that one would incorporate (as opposed to doing an LLC) to reduce the SS tax hit, if this isn't even necessary...

Would you be able to refer me to an IRS reg or publication that speaks to this? Not questioning your accuracy, just want to do some DD.
It's the section 7701 Treasury Regulations, at 26 C.F.R. sec. 7701-1 et seq. They were finalized in 1996; I'm not sure exactly when they became effective.

The specific rule that single-member entities can elect to be "associations" (and, therefore, corporations for tax purposes) is in section 7701-2(a)
[Q]-Since we're both officers, then meetings, trips, even lunches where we do bona-fide business qualify as valid business expenses and are therefore deductible. (Since LLCs don't have a corporate structure, my understanding is that there'd be less room for legitimately doing this there.)
I don't think there's any reason to expect the IRS to care. If you someday end up in front of a jury, I suppose that the word "corporation" might help a little in making it all sound businesslike, but I wouldn't expect to get much mileage out of that.

An LLC is a business entity, too; there's really no reason to care what the papers say, except where the law gives one an advantage (like less formal nonsense for LLC's than for corporations).
[Q]I would be most interested in hearing more (links and references would be great also) about the "lots of disadvantages...and very few advantages" of s-corps over LLCs.
There are two issues here. One is corporation vs. LLC (as a technical matter under state law). There, the issue is basically that corporations are more widely understood, vs. having to deal with more formalities and, therefore, more risk you'll screw something up and find out, say, that your limitation of liability doesn't work anymore. Also, an "incorporated entity" -- i.e., a true corporation -- can't elect to be anything else, whereas just about any other entity, including an LLC, can go either way.

The other issue is a pure tax issue: do you want your LLC to be taxed as a corporation or a partnership (or disregarded entity, if it has only one member)?

As a corporation, you could be a C corporation, which might make sense to take advantage of the 15% bracket, if you (1) are in a high personal bracket, (2) plan for your business to earn only a little bit of income, but never have losses and (3) do not plan to make many distributions. You gain, potentially, a present tax savings in return for losing a lot of flexibility and risking higher taxes later.

If you don't want to be a C corporation, your choices are, basically, partnership/disregarded entity or S corporation. Either one is taxed on a passthrough basis -- income and other tax items of the partnership end up affecting the personal returns of the members.

Being an S corporation could have an employment tax advantage, but the IRS would be free to recharacterize your "dividends" as compensation for services and so to demand employment taxes on them. If you are willing to be aggressive, you might as well take the position that LLC members are "limited partners," so that, BY STATUTE, their non-guaranteed shares of profits are automatically exempt from employment taxes.

In any case, paying less employment taxes isn't always desirable, since it could cut your social security benefits someday. (This does not apply if, for example, you are earning the maximum anyway, in which case minimizing employment taxes is smart, though it's never a huge dollar amount.)

As to income taxes, being a partnership rather than an S corporation has significant advantages:

1. You're not subject to S corporation limits (75 shareholders, all individuals, all Americans, all holding the same "class of stock", etc.)
2. You have a greater ability to deduct losses, since indebtedness of the entity adds basis for all the partners
3. You can allocate different items of income differently. For example, say there are two members, one of whom is in the 0% bracket and the other in the top bracket. The 0% member doesn't care about the difference between ordinary income and long-term capital gains, but the top-bracket member is paying 35% vs. 15%. It will often be possible, subject to some EXTREMELY complex rules, to be treated as disproportionately earning LTCG for the rich member and ordinary income for the poor one.
4. The partnership can adjust the basis of its assets upon a transfer of membership interests.

Partnership taxes are very complicated, but creativity can be rewarded with lower tax bills.

S corporations do have two other advantages:

1. They can participate in reorganizations. The one common place this matters is where a private business is acquired by a merger with a public company. But a partnership wanting to do this (and unable to structure the transaction differently) would just need to "check the box" to become a corporation for tax purposes, and it would be very, very difficult for the IRS to argue that should be ignored. So this is a very minor advantage.

2. S corporations can have ESOPs, which is a huge advantage where available. But you need at least 10 employees for that to be possible, and for the employees to own the business.

Thanks LH2004. Lots to ponder here.

I agree that given their ability to be taxed like S-corps after all, for truly small businesses the flexibility LLCs afford would greatly outweigh benefits like ESOPs and reorganizations.

Had I been properly informed on this, I might have gone the LLC route.


I'm still curious about what you meant by the "different kinds" of income point and the point that new businesses will find LLCs "generally preferable" (if that's for a reason other than the previously discussed flexibility.)


Am also still puzzled why all the literature I've seen previously on this omits the key fact that LLCs, among other "associations," can opt for S-corp tax treatment.

DaveHanson said: [Q]
Had I been properly informed on this, I might have gone the LLC route.


If you have an existing company that you set up as a corporation and you now want to become an L.L.C, see if your state allows for the merger of a corporation and an L.L.C.

As long as the surviving L.L.C. chooses to be taxed in the same manner as your current company, the IRS will view the reorganization as an F-reorganization (basically a name change). There are some PLRs on this exact point and, if I get the time, I'll post the numbers.



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