What are the differences between an LLC and an S Corp?
Often, I encounter small business owners who want to know the differences between an LLC and and S Corp. If you are reading this article, I assume that you know all about limited liability and separate entity status of corporations in Virginia. If not, I suggest that you contact my office or look to Title 13.1 of the Virginia Code.
Other than shielding the personal assets of a member/shareholder, the major benefit of both an S Corp and a Limited Liability Company (“LLC”) is lower overall tax liability. All profits of an LLC pass through to the individual owners and are not taxed at the corporate level. Essentially, they are taxed very similarly to a sole proprietorship or partnerships in that the tax rate is determined by the income of the indivudal member/shareholder. S Corps take a slightly different approach in that the owner/member/shareholder is paid a reasonable salary for their services.
A company must “elect” S Corp status through the IRS.
In order for a company to become and S Corp, they must “elect” that federal tax status by using IRS Form 2553. The S Corporation election was enabled by federal tax regulation IRC Sec. 1362. In order for a corporation to elect S status, all shareholders must consent to the election. In fact, the rules require that all of the shareholder/members sign IRS Form 2553.
Part of the confusion lies in the fact that an S Corp is not a separate entity at all. Rather, it is an election which a corporation or LLC may choose to make. Let me attempt to explain. Corporations and LLCs are created under the corporation law of each individual state. In Virginia, our corporations are governed by Title 13.1 of the Virginia Code and regulated by the State Corporation Commission. When a company elects S Corp treatment under the federal tax laws, they are not forming an entirely new organization. Rather, they are changing the tax status of an existing corporation. In fact, an LLC may elect S Corp status and there may be some benefits to doing so.
S Corp election may result in significant self-employment tax savings for the business owner. However, it is also possible that it may lead to additional paperwork and filings annually. Remember, in order to benefit from S Corp status, the corporation must pay the owner a “reasonable” salary. Of course, the IRS is beginning to scrutinize more heavily what a reasonable salary is.
In conclusion, there may be benefits to your company in choosing S Corp status. If this is something you are considering, it is often good to speak with both a lawyer and an accountant. Before proceeding, you want to make sure that S Corp election makes sound financial sense for your company.
Every case presents unique facts and no outcome can be guaranteed by an attorney. Give my office a call to discuss your particular needs or concerns.
Ryan C. Young | Richmond, Virginia Attorney | Small Business Law