Is your business an LLC or an S Corporation? | Accounting and Tax ...

Limited Liability companies (LLCs) started as having uncertain tax effects but now?have become one of the most popular structures used for a new business.? However, LLCs do not exist as an entity under the Internal Revenue Code (IRC).? According to the IRC, a for profit entity must be an individual (sole proprietor), partnership, trust, or corporation.? The regulations known as the ?check the box? regulations became effective in January 1997 allowing multi-member LLCs to elect to be treated as either a partnership or a corporation.? And a single member LLCs could elect to be treated as either a sole proprietor or a corporation.? If an election is not made, a multi-member LLC is tax as a partnership and a single member LLC is taxed as a sole proprietor.? If an LLC wishes to be taxed as an S Corporation, the member(s) would simple need to file Form 2553 to elect S status.? If this election is made (or if the ?check the box? election is made to be tax as a corporation), the entity is deemed to transfer all of its assets and liabilities to the corporation in exchange for the corporation?s stock.? The entity is then deemed to distribute the corporation?s stock to its owners in complete liquidation [Reg. 301.7701-3(g)(1)].? With some exceptions, the deemed transfer to the corporation is tax-free [for the tax code junkies, see IRC Sec 351(a) and Sec. 357(c)].

Why an LLC and not just an S corporation?

Because LLCs are either taxed as sole proprietors, partnerships or corporations, this adds to the confusion and understanding as to what type of entity a business is operating under.? I have been asked several times, ?if we, as members of an LLC, elect to be tax as an S corporation and we are deemed to have transferred assets for stock of an S corporation, why wouldn?t we have just set up an S corporation from the beginning.?? This is a great question.? First remember that in Florida business entities are formed under state laws but are taxed according to federal tax codes.? Therefore, if the S corporation election is made the entity is still considered an LLC for state legal purposes.? State laws would cover topics such as piercing the corporate veil, charging orders available to creditors, and liability protection.? I am not an attorney so these topics should be discussed with your corporate legal professional.? However, just to touch on a few items, Florida Legislature often applies existing corporate law regarding piercing the corporate veil to determine when an LLC?s veil of limited liability should be pierced and the individual members held responsible for the torts and contractual obligations of the LLC.? However, because LLC?s are relatively new entities, Florida courts have been reluctant to pierce the LLC veil and will typically only do so when the LLC is considered a sham, instrumentality, or alter ego of its principals and was formed or used to further improper conduct or to perpetrate a fraud.

Charging order protection of an LLC.

The ?charging order? of a creditor offers another layer of protection for an LLC member.? A charging order provides a creditor with the rights of an assignee, which entitles a creditor to receive distributions to which the debtor-owner would otherwise have been entitled.? However, creditors cannot vote on business matters, inspect or copy business records, nor exercise any of the debtor-owner?s rights with respect to the management of the business.? Owners of a corporation do not have this similar benefit; their creditors are not limited in their remedies to a charging order.? It is also believed that the creditor-owner of an LLC may be subject to tax on a phantom income.? Since they are considered owners for tax purposes, the creditor-owner would be subject to tax on the assigned portion of income regardless of whether the profits have been distributed.? This obviously makes LLC ownership less attractive to creditors for debt collection.

In Summary

Initially setting up an entity as an LLC and simultaneously electing to be tax as an S corporation through the filing of Form 2553 by the LLC members, state law protection and the added pass-through taxation benefits of an S corporation are combined. The entity, therefore, is both an LLC for state protection and legal concerns and an S corporation for federal income tax purposes.? Understand who you are talking to or the topic of the discussion when voicing what type of entity classification your business is operating under.

Care should be taken when writing the by-laws of the LLC to include provisions that would not disqualify the entity from being classified as an S corporation from such actions as allowing more than one class of stock.? A second class of stock would make the LLC ineligible to be taxed as an S corporation.? Although the legal ramifications should be discussed with an attorney, this combination of entities offers asset protection, limited liability, and the lowest pass-through taxation benefits for owners employed by the business.?

There are many other tax and legal steps that should be considered when deciding on the proper business entity and tax classification and should be discussed with your accountant and attorney.

Source: http://www.askati.com/is-your-business-an-llc-or-an-s-corporation/

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