LLC - Disregarded Entity vs. Corp. or S-Corp.

[Tino Julian]

Hey BP Community,

I've got a pretty straight-forward tax question (BUT...all my internet research has not been able to give me a clear-cut answer). I have an LLC and was about to apply for an EIN on the IRS website but they ask "how many employees are involved in this company?" What are the tax advantages of filing as a "Disregarded Entity" vs. a Corporation?

I know this is a pretty basic question but I am just getting started in Real Estate and don't want to get hit with a HUGE tax bill at the end of the year.  I am also in the somewhat unique position in that I have two family members who can help me with this business (although I am going to be doing the bulk of the work).  When I enter "1" on the IRS application it says "for tax purposes your business will be considered a 'Disregarded Entity'" (with the explanation of what that means).  When I enter "2" it tells me that my business will be considered a "Partnership" and when I enter "3" it tells me that it will be considered a corporation.

I completely understand that by listing my LLC as a corporation, I am adding additional forms and accounting headaches to the mix, but is there a distinct TAX ADVANTAGE for doing this? If I go the "Disregarded Entity" route, can I easily switch to a "corporation" at a later date (when the business grows)? Finally, someone recommended an S-Corp to me but this sounds even more complicated (from a Tax standpoint) - has anyone got experience with this & WHY would I want to go that route?

Thanx. 

[Brandon Hall]

@Tino Julian there have been tons of posts on BP and also articles detailing the pros and cons of each entity. 

What you don't mention is what type of real estate you are doing. Are you flipping, buying and holding, wholesaling, developing, building, etc? Knowing this will drastically change the conversation.

Additionally, you really shouldn't be setting up an entity without first consulting a professional unless you have a really good grasp on the implications that come with it. People who have a really good grasp on the implications are usually attorneys and CPAs, so no one else should be setting something up without receiving a professional's advice (advice not rendered over a public forum).

The IRS is not asking about employees. It's asking about partners. The question is: are you going to have partners who have an interest in the company? If no, a single member LLC may be the way to go. If after speaking with an attorney you realize you need a partnership for creditor defense, then a partnership (still an LLC, just not single member) is the way to go.

You will also want to first check with your state's filing process prior to obtaining an EIN. This will help avoid potential future headaches. 

After establishing the entity, you can file elections for S or C status. S-Corps are passthrough but allow you to pay yourself a salary out of the portion of net income. This allows you to limit the amount of your profits subject to self-employment (SE) tax. LLC and partnership profits are fully subject to SE tax. S-Corps also have the added benefits of non-taxable dividend distributions, which is not the case for C-Corps.

C-Corps are amazing if used properly, but usually not good for the average business owner as a holding company. C-Corps work well when established separately to provide services to your organization. Reason being that as long as net profits are less than $50,000, the tax rate is 15% which can be much lower than your ordinary rate in which S-Corp, LLC, and partnership income are all subject to.

So you could set up an LLC/S-Corp, and then set up a separate C-Corp that provides services to your LLC/S-Corp equal to $50k/year, and effectively move money into the C-Corp and realize significant tax savings. It gets really technical, but that's the gist of it.

C-Corps used improperly can be a nightmare. Not only do you have admin headaches, but you have double taxation on the net profits (taxed at the corporate level, and again when you take a dividend).

So, moral of the story, STOP NOW and connect with a pro.