Why do investors choose LLC's over S-Corp's?

[Brian Garrett]

I always see discussions where investors ask about creating an LLC for their business.

How come people never discuss S-Corps? Are they not common in the World of REI?

I currently own several S-Corps in other industries so I'm familiar with the structure of them, the requirements for them in my state, the tax benefits of them, etc.

Is there a downside to starting a new S-Corp to run all of my real estate investment endeavors through? Why are LLC's always suggested and that much more common?

Thank you in advance!

[Linda Weygant]

Reasons to choose an LLC over an S-Corp:

1.  If you have more than 20% of your revenue in an S-Corp coming from Passive Income, the IRS can nullify your S election and convert you to a C Corp.  S-Corps are intended for ordinary income.  Capital Gains and losses lose their tax advantaged structure in a C-Corp, so this is something to be VERY careful of.  If you combine rentals and active income in an S-Corp, it works really well - until the year comes when your rental income goes over that 20% threshold or the year in which you sell a rental property.  All of that capital gain is passive income and if it's up over 20% of your total revenue, you've put your S-Corp at risk for C-Corp conversion.

2.  The owner has other income, usually W-2 income, that is very close to or over the Social Security maximum.  An S-Corp in this situation causes unnecessary additional taxes to be paid due to the requirement that the S-Corp officer/owner MUST take a "reasonable" salary and additional SS/MC must be paid by the Corp that is then "lost".

3. The owner wants to maximize contributions to a SEP. SEP contributions in an S-Corp are limited to the amount paid in salary while SEP contributions in an LLC are limited only to the overall profits.

4.  One of the owners is a foreign national or other entity.  Foreign nationals and entities may not be shareholders in an S-Corp.

5.  Owners do not want to be or cannot be disciplined enough to deal with quarterly payroll taxes.

6.  Company employs non-owners and the complications associated with contributing to employees' retirement or other benefits is not desired or overly complicated.

Reasons to choose an S-Corp over an LLC:

1.  The activity is active in nature (flipping, wholesaling, real estate agent, etc).  Any business where you are providing services or selling something is eligible.  (Providing a rental property is not providing a service).  

2.  Tax savings of between 33% - 66% of SE Tax.  (However, there are extra expenses involved in being an S-Corp.  Make sure your tax savings are worth the additional expenses).

3.  Retirement plan structures that are geared more towards S-Corps that are favorable to the owner.

4. Since owner is doing payroll anyway, it's easier to pull in owner's minor children onto salary (great tax savings strategy on this). This can still be done in an LLC, but gets more complex. You can pay your minor children age 7 and older up to $12,000, put money in an IRA for them and pay no taxes on any of it (restrictions apply. Make sure you understand them all).

Probably more.  I'll edit this when I think of them.