03 Sep Forming an LLC or C-Corporation, and Why Be Taxed as an S-Corporation For Your Small Business?
If you are starting a business or own a small business currently, then contact our team to discuss your specific requirements and our suite of small business services. If you would like general information, then proceed reading below.
There are many reasons to form a Limited Liability Company (LLC) for your small business. Recently, we have seen our small business clients forming more LLC entities versus Corporate entities. You can form your business entity as either an LLC or Corporation, and then choose to then be taxed as an S-Corporation for tax purposes. Please note that this isn’t legal advice. As tax accountants, we refer to business law attorneys for that. This is for your further understanding some of the basic and general reasons you likely see other businesses forming as LLC legal entities in Florida.
In Florida, the state fees for renewing the LLC are slightly cheaper and the penalties for not renewing on time are less than that of Corporations. These are very minor factors, however, in my opinion. In certain circumstances, business law attorneys may reference certain additional creditor protection of LLCs versus Corporations. Again, this is for the attorneys to explain, and they should be able to explain this as it specifically relates to the small business owner that you are, and not to the very large company with many owners that you are not. Make sure they are aware of your size and number of owners so they can cater their discussion to your specific legal situation, and how your business obtains debt, as most of the time small business owners have to personally guarantee loans anyway (SBA loans and other bank loans, etc.).
If you are a single-owned (single-member) LLC, this is considered a ‘disregarded entity’ by the IRS. This means that you have the legal asset protection entity benefits of the LLC, while not having to prepare a more complicated ‘corporate’ business tax return during tax season. Basically, you would still file as a sole proprietor on your Form 1040, Schedule C, but have the legal benefits of the LLC entity. This may save you fees and time with your tax preparation at year-end. However, this may not be the best entity treatment for tax purposes, especially if you are profitable.
LLC entities, taxed as such, have income tax on the net income, and the income is passed through to the members based on their ownership percentage. They ALSO have self-employment (SE) tax at a rate of 15.3% on that pass-through income.
When profitable, especially as a single-owned (single-member) LLC, you will want to explore possibly having the entities tax treatment changed (with a Form 2553 election filed timely) to an ‘S Corporation’ for tax purposes – where there is NO SE (15.3%) tax on the profits. In this case, you will still be an LLC for legal entity purposes but treated as an S-Corporation by the IRS for tax purposes. When you do this S Corporation conversion for tax purposes to an S Corporation, you must take “REASONABLE COMPENSATION OF OFFICERS.” This is a reasonable owner payroll, to the owner/officer, based on the owners/officers job title and experience, and many other factors, not fully discussed here. When an owner/officer takes a salary they will have more requirements of payroll services, and tax preparation for our team to guide them with and to provide to them. However, if taken care of properly, under IRS guidelines, they may benefit from additional tax savings.
Sometimes, the LLC tax treatment often offers the most flexibility when a business is uncertain about profitability starting out, since you can change to the S Corporation for tax treatment reasons later when you are profitable (using Form 2553 and using specific IRS Revenue Procedures). The decision for an entity to be taxed as an S-Corporation is often based on your individual timing for your business formation, your business size, your business ownership structure and the expected timing and amount of business profitability – again, legal and further tax advice are necessary for your specific requirements.
If your business is NOT a single-owned (single-member) LLC, and your business has multiple owners, there may be more flexibility among members being paid differently (guaranteed payments, etc.) to stay as an LLC for tax purposes. There may be greater flexibility when assets are being converted in and out as an LLC entity by members – among other factors. However, proper discussion with a small business attorney is needed when making this decision, as legally it is important to understand this among all of your members (owners) what you want to do and what you can do. You would also need to speak with our tax accountants to determine this, as it can get very complicated when there are other members (owners) in a business. Even so, an S-Corporation treatment of your multiple-member LLC may be the best overall option, and usually is. However, there are times where this is not the best overall option for a multiple-member LLC. The requirements of the owners may be specific and important to them versus the possible tax benefits of the S Corporation. The S Corporation tax treatment of the LLC may negate some of the aforementioned flexibility among the LLC members wanting to be paid not proportionate to their ownership percentages. Most small businesses are single-owned, and this complicates things when adding partners, which warrants much further discussion if you are considering becoming a business partner with others.
Often times small businesses will still form as a Corporate entity, typically because they are more ‘familiar’ with that structure. However, it is rare that they will stay as a “C-Corporation” for tax purposes when formed. When a Corporation is formed it is ‘born’ as a C-Corporation for tax purposes. In this case, the election to be taxed as an S-Corporation is more common than not, and is usually converted almost immediately after formation. This conversion from a C-Corporation tax status is usually due to tax savings possibilities that the S-Corporation tax treatment provides over the C-Corporation tax status. The C Corporation has a ‘double taxation’ component, as there is a tax on its profits AND ALSO dividends paid to its shareholders. S-Corporations are taxed on the profit as a pass-through entity to its owners, but not on its dividends (called shareholder distributions in an S-Corporation). It is again important to note the importance of also taking reasonable compensation of officers when profitable in an S-Corporation, as discussed prior. It is unusual but sometimes required, for a small business owner to be taxed as a C-Corporation. The reasons can be because of foreign ownership, many owners, or other factors. There is also a legal requirement in Florida to take ‘minutes’ in a Corporation entity.
Before forming an LLC or Corporation, it is best to contact one of our tax accountants to make sure you are on the right track, especially as it pertains to the possible S-Corporation tax savings. We can refer you to a small business attorney for your legal questions. While recently we have seen that single owned small businesses are more often formed as LLCs taxed as S-Corporations, your specific circumstances may be different than others.
We are here to advise you as our valued client! We provide all of the services you need to make your entity decision a compliant and viable tax savings option, and the services to run it smoothly – including, bookkeeping, payroll, tax, consulting, planning, start-ups, sales tax, and financial reporting. We are USA small business tax and consulting financial experts – Since 1992. Contact us to get started today! www.UnbehagenAdvisors.com 727-934-7759.