When it comes to managing your business or your real estate investments, selecting the right business structure is critical. After all, the legal and financial ramifications can be significant. In previous posts, we discussed the LLC (Limited Liability Company) and its pass-through tax advantages. Another business structure, the S Corporation, also allows owners to report profits and losses on their personal tax returns. However, there are some differences between the LLC and the S Corporation that have big implications for both the business owner and the real estate investor. Here are the key factors to consider in selecting the right business structure (LLC or S Corp) for your particular business or transactions:
The Limited Liability Company (LLC)
As a recap, in an LLC, the owner’s personal assets are shielded from business liabilities just as they would be in a Corporation. In addition, the IRS views the LLC as a “disregarded entity”. Thus, an LLC does not file separate taxes; company profits and losses flow through to the owners and are subject to each owner’s individual tax rates. The LLC is great for a business that wants liability protection, but seeks minimal formality. It’s also the perfect structure for a business with foreign owners since anyone (C Corp, S Corp, another LLC, a trust, or an estate) can be an owner of an LLC.
The S Corporation (S Corp)
An S Corporation begins as a plain vanilla C Corporation. Soon after incorporation, shareholders must submit Form 2553 to the IRS to be treated as a pass-through entity. While both the LLC and S Corp offer pass-through tax treatment and personal asset protection, there are some key differences:
1. The S Corporation restricts who can be a shareholder
An S Corp cannot have more than 100 shareholders (of course, this limitation is probably not of much consequence to most real estate investors). All individual shareholders must be either U.S. Citizens or permanent residents. The LLC does not have such restrictions on owners.
2. The S Corporation has strict income allocation
In an LLC, income and loss can be allocated disproportionately among the owners; in the S Corp, income and loss are assigned to each shareholder strictly based on their pro-rata share of ownership. So, if I own 80% of an LLC, my share of the tax burden doesn’t necessarily have to be 80% of the taxable income. But if I own 80% of an S-Corp and that company makes $100,000 in taxable income, I will be taxed on $80,000 of income.
3. The S Corporation cannot increase pass-through losses
In certain circumstances, the IRS allows the loss in a corporation or LLC to pass through to the individual shareholders. For real estate owners, these losses can provide an enormous reduction in an individual’s overall tax liability. However, the LLC allows you to pass through more loss than in the S Corp – most notably when it comes to mortgage payments. In an LLC, members are allowed to add the amount of the mortgage to their basis for the purpose of computing a loss. Clearly, that can add up to a significant difference in your tax statement.
Of course, details may vary based on your specific circumstances. However, in most cases the LLC is the ideal business structure to both protect your personal assets and offer the maximum in tax benefits.
Download CorpNet.com’s Free Incorporation Guide or Free LLC Guide to get all the details about the distinctions between the two structures. You’ll learn that overall, an LLC is the less formal entity. Of course, details may vary based on your specific circumstances, so take some time to educate yourself on these two business structures.
Whether you ultimately select an S Corporation or the LLC, you will have to file Articles of Incorporation or Articles of Organization with your Secretary of State to bring the S Corporation or the LLC into existence.
CorpNet’s professional staff is here to assist you every step of the way… And once you know what you’re required to file, we can take care of the details for you! If you have specific legal questions or concerns, you should consult an attorney for sound advice. After all, your business is worth it.
Please feel free to reach out to me with any questions to firstname.lastname@example.org.
I wish you the best of luck in all of your business endeavors!:)