Developer · Andover, MA · Member since 2008 · 1k+ posts · 489 votes
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?
Real Estate Attorney · Cleveland, OH · Member since 2011 · 140 posts · 89 votes
14y
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....
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
14y
Originally posted by Justin Silverio:
Are there any other legal differences? If not, it seems like there is no benefit to going to LLC route?
I think you mean, "...there *IS* benefit to going the LLC route."
And, based on my experience and knowledge, I see little reason to set up an S-Corp vs an LLC taxes as an S-Corp, unless you plan to have shareholders or need one of the more uncommon aspects of a corporate shell for small business owners.
Developer · Andover, MA · Member since 2008 · 1k+ posts · 489 votes
14y
Hey J Scott. I was actually hoping you would post on this thread because I know you set your company up as an LLC w/ S election. I understand that each state governs the laws of business entities so I'm wondering if GA has some material differences between the two? From my research and talking with several accountants/attorneys, I don't see much of a difference in MA.
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
14y
Let me explain it this way. You can have a regular S-Corp (incorporate and file form 2553). This is the typical S-corp.
A single member LLC is automatically treated by the IRS as a disregarded entity. Meaning you would file a Sch C for a business and Sch E for Rental activity. The reason for the S-corp Election is if you have two or more member and would like to take in some of the profits as a distribution rather than wages. For example, You may have a silent partner who won't want to have to pay SE tax on all of the income. He would not receive a w-2, he would receive a K-1 to show his receipt of income.
With the LLC filing as an s-corp this is only a tax classification, no board meetings required or anything.
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
14y
Just to make a quick clarification:
- From an IRS/tax perspective, there is absolutely no difference between an s-corp and an LLC taxed as an s-corp. They are the same thing from the IRS' perspective;
- From a legal/asset-protection standpoint, the difference is between a corporation and an LLC, and from a legal/asset-protection standpoint, the election of s-corp is meaningless.
So, while I'm certainly no expert on this topic, make sure that when you talk about the differences between the two, you specify if you're referring to the tax implications (no distinction) or the legal/entity implications (likely big differences depending on statute, structure, number of owners/members, etc).
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
14y
Originally posted by Justin Silverio:
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).
I don't know exactly what you need to pay the state of MA in annual fees. But, an LLC is not a corporation. An LLC that has elected to be treated by the IRS as an S-Corp is still an LLC -- not a corporation -- and should only be viewed by the state as an LLC.
I don't get why the state would charge one business entity annual registration fees twice: first as an LLC and again as a corporation.
Maybe you meant that the state charges the LLC (S-corp) the higher corporate tax fee. If so, then you need to confirm that this is really the case. If there is a lower annual registration fee for the LLC, then the LLC treated by the IRS as a corporation for tax purposes should only pay the state registration fees for an LLC.
Originally posted by Justin Silverio:
Are there any other legal differences? If not, it seems like there is no benefit to going to LLC route?
The LLC is governed by the laws of the state and its legal protections derive from state law. At the state level, if the state law governing the LLC is the same as the state law governing the corporation, then you may be correct that there are no legal differences at the state level.
However, you should also note that the S-corp does issue stock. If a shareholder is sued personally, then all his personal holdings are exposed to liability. The shareholder could lose his stock in the corporation to a creditor. If this, then, makes the creditor a majority shareholder in the corporation, the creditor could force liquidation of the company. Regardless, the shareholder loses his interest in the company.
On the other hand, the LLC treated as a corporation for tax purposes, is still an LLC under state law. The LLC does not issue stock. The creditor with a judgment against a member of a multi-member LLC is normally limited to charging order protection. In this case, the creditor is not able to seize control of the company and force liquidation to pay off a debt.
Real Estate Investor · Northeast TN, TN · Member since 2008 · 516 posts · 361 votes
14y
Originally posted by Justin Silverio:
Steven - I don't see where it says that you don't need to pay the filing fee for both an LLC and S Corp. Going to look into this as well.
Justin, under MA law your entity will be classified as either a corporation or a Limited Liability Company (LLC). It will NOT be both. It will pay the fees appropriate for its classification.
That being said, both the corporation and the LLC can make an election to be taxed as an S-Corporation. This election is strictly for tax purposes at both the federal and state level.
The decision regarding S-election should be based on your investing strategy. If you are a "buy and hold" investor, an S-election would probably be a horrible idea. You should review your investment strategy and tax situation with your tax pro. He (or she) would be in the best position to advise you since an S-election is based on tax, and not legal, issues.
Developer · Andover, MA · Member since 2008 · 1k+ posts · 489 votes
14y
thanks Bill. This entity would be strictly for flips, therefore I believe the S corp election is the way to go. I'm really just struggling with the differences on the asset protection side. Dave made some good points - will have to follow up with my attorney.
Real Estate Attorney · Cleveland, OH · Member since 2011 · 140 posts · 89 votes
14y
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....
Developer · Andover, MA · Member since 2008 · 1k+ posts · 489 votes
14y
Thanks for the great replay Keith. A couple follow up questions. If the creditor takes possession of the C corp stock, which gives them majority share of the company, can they then liquidate the company? If that's the case, I can see that this is a big difference in how the courts settle Shareholder vs. member debts. Would you say that this is the greatest discrepancy re: asset protection?
Real Estate Attorney · Cleveland, OH · Member since 2011 · 140 posts · 89 votes
14y
Originally posted by Justin Silverio:
If the creditor takes possession of the C corp stock... can they then liquidate the company?
....
Would you say that this is the greatest discrepancy re: asset protection?
Generally speaking, if a creditor is allowed to take possession of the shares of stock, they can sell those shares (which is worthless in a private corporation); however, there may be a requirement to sell the shares back to the corporation, etc.... Shareholders have no authority to liquidate a corporation. Shareholders can only vote for members of the board of directors. Therefore, if a creditor has enough shares of stock, the creditor could vote in new board members, the new board members could choose to liquidate corporate assets AND/OR appoint new officers. New officers could liquidate corporate assets: this depends on who has the power to take what actions in the corporation.
Being wealthy (and having enough assets that are worthy of jumping through large hoops to protect) does not necessarily mean owning lots of things. In fact, own as little as you can (personally) and control as much as you can. Control is what gets you the cash flow/wealth.
Because you cannot always control your ownership of shares of stock as readily as you can control your membership interest in an LLC - yes, this is a big reason why an LLC is better for purposes of asset protection.
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
14y
Originally posted by Tim Gordon:
Look into two books written by Mark Kohler, he spells it all out.
Laywers are Liars & What your CPA isn't telling you.
I've met Mark Kohler and heard him speak and would agree he is a very astute CPA/lawyer when it comes to real estate law. There are many tax professionals out there that do not understand a lot of the tax implications of the many ways of transacting in real estate. Not sure that I would agree to call them liars or cheats though.
There are good CPAs, lawyers and tax professionals you just have to do your due diligence. I would say Mark is a good CPA and seems to be a good RE attorney.
Accountant · Hyattsville, MD · Member since 2011 · 120 posts · 44 votes
14y
I agree with all of the above except to say that since there are no other differences, it's best to got with the LLC because the compliance requirements are more lenient.
Developer · Andover, MA · Member since 2008 · 1k+ posts · 489 votes
14y
Ebere - Even though I'm not completely convinced there are critical differences between the two entities, I'm going to go the LLC route for the reason you mentioned - less formalities = less susceptible for someone to pierce the corporate veil.