The LLC or S Corporation Choice


With some frequency a potential buyer will ask if he should form a legal entity with which to operate the business once the purchase is finalized. The answer is generally yes when issues of liability and tax are considered.  As liability is a question of law I will always suggest that an individual who wants to explore that subject  confer with their attorney .  However,  I am always happy to talk to issues of tax.There are positive and negative factors to operating in each form of business,   but a few things in my mind are critical:

An LLC is essentially a partnership and a “flow through entity” . The earnings of the entity are going to pass through to the members and be subject to both income tax and ( generally)  self – employment tax . The self-employment  tax is 15.3% , which represents  both sides of the  SSA and Medicare tax paid on wages in a salary man situation.

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For all California source income the LLC will be charged a fee based upon income ( Sales) which ranges from a low of $900 to a high of $11,790 depending  on  the revenues  of the business.  

If you are planning to purchase real estate , have non resident aliens as investors,  or plan uneven distribution of profits a case can be made for the LLC .  Also professional service providers will often establish themselves in the LLC structure for reasons that need not be explored here.

The S corporation ( also a Flow Through Entity)  is more formal in it’s structure  and can have up to 100 shareholders , all of whom have to be  US citizens or residents.  Estates and certain trusts can be shareholders.  It is critical that all distributions ( but not wages)  reflect the pro rata shareholder interests in the corporation.

However ,  if the shareholder operating the business is paid a “reasonable salary” the remainder of the profits  are not subject to the self employment  tax and a substantial tax saving can be achieved. The tax code does not define “ reasonable salary” and the argument  with IRS is always challenging . There are no additional fees paid to California in this type of entity, although they do assess a tax of 1.5% of net taxable income .

 Do not put real estate into an S corporation .

The above is a simple analysis of the issues and should not be considered either exhaustive or formal. It is possible for an LLC to file income taxes as an S corporation but there are complex rules to this strategy.

The tax code is complicated and each individuals situation different . This requires that you consult with your own legal and tax advisors.

 Glad to talk this over with anybody  seeking  further information.