LLC w/ S Corp Election vs. C Corp w/ S Corp Election

[Justin Silverio]

There have been a couple of posts about this in the past but no definitive answers came out of them. My question is why would someone set up an LLC and elect to be taxed as an S Corp instead of just taking the S Corp election via a C corp?

I have outlined what I believe to be the differences of each below. I live in Mass so this may be different in your state. From what I can tell, both are treated exactly the same for tax purposes (S Corp) but there are a few minor differences on the legal side.

1. It's easier to set up an LLC than an S Corp

2. Less formalities with an LLC (don't need to hold annual BoD meetings, etc.) - Not a big deal at all - although if you don't follow these formalities, someone could pierce the corporate veil

3. Costs for an LLC w/ S Election - you need to pay the annual fee for both an LLC and a C Corp (approx. $775 in Mass)
Costs for a C Corp w/ S Election - only need to pay the C Corp annual fee (approx. $125 in Mass).

Are there any other legal differences? If not, it seems like there is no benefit to going to LLC route?

[Keith Barton]

Just to put some of the pieces together....

Short Answer:
There is no difference in taxation of an LLC or a Corporation electing to be taxed under Subchapter S. However, LLCs have much more protection from liability than do Corporations.

Long Answer:
States (normally) only recognize Corporations. States do not distinguish between S Corporations and C Corporations. Only the IRS distinguishes between S Corporations and C Corporations. The name S Corporation comes from the tax laws governing how an S Corporation is taxed: Internal Revenue Code, Subtitle A, Chapter 1, SUBCHAPTER S. The name C Corporation is used only to distinguish one taxable entity from another taxable entity (there is no Subchapter C, which governs how a C Corporation is taxed.)

Because the "S" simply refers to a section of the tax code, choosing to tax an LLC as an S Corporation affect ONLY the rules used to tax the LLC - NOT the rules to form or operate an LLC, nor the rules that determine the liability of the owners of an LLC.

LEGAL REQUIREMENTS & LIABILITY
Legal Requirements:
The rules to form and operate a Corporation are different from the rules to form and operate an LLC. These rules are created by the states. The rules to form and operate an LLC are less strict, less formal, and more flexible than the rules to form and operate a Corporation.

Liability:
LLCs offer much more protection against liability than do Corporations. There are two ways liability can be a problem: 1) the owner of a business entity may have to pay the debts of the business entity; or, 2) the business entity may have to pay the debts of the owner of the business entity.

Business entity owes money:
Corporations - shareholders cannot be made to give up their shares of stock if a Corporation owes money. Shareholders cannot be made to pay money to creditors simply because they own shares of stock. Shareholders can lose all of their investment in the Corporation (Corporation assets are seized and sold off causing the Corporation to go out of business, which renders the stock worthless.)

LLC - Members cannot be made to give up their ownership interest in the LLC. Members cannot be made to invest more money into an LLC to pay creditors. Members can lose the LLC if the LLC becomes worthless because creditors seize assets and sell them off, causing the LLC to go out of business.

Individual owes money:
Corporation - a Corporation cannot be made to pay the debts of individual shareholders. A shareholder who owes money to a creditor can be forced to turn over their shares of stock to satisfy the debt.

LLC - a Member of an LLC cannot be forced to turn over ownership of the LLC to satisfy debts to creditors. An LLC cannot be forced to satisfy the debt of an individual Member. However, if an LLC is going to pay money to the Member who owes a debt, a court can prohibit the LLC from giving the money to the Member and can instead make the LLC turn over the money to the creditor (this is a charging order). By the way, courts cannot require LLCs to make a distribution (pay money) to a Member, it can only say if you are going to pay money to a Member you have to turn it over instead.

As long as this post is, it really is just a summary....