Blog

Advantages of LLC

Advantages of LLC As a Certified Public Accountant I often encounter the question should I become a s-corporation or LLC? What are the advantages of LLC? Even though I understand why people ask the LLC or S Corp question, I realize the information is based on incomplete knowledge. You can be a straight s-corporation or a LLC taxed as a s-corporation. Which one is most beneficial depends on your unique situation.

S Corporation versus LLC

When choosing your business structure, there are 2 different levels to consider:

  1. The Legal structure: This is normally done at the state level. Paperwork is filed with the state to determine the legal form of operation. For example the LLC, corporation or partnership
  2. The Tax Structure: Once your legal structure is formed you can elect to be taxed more favorable by making applicable elections with the internal revenue service. An example is the s-corporation.

A s-corporation is simply a corporation which operates under the Subchapter S rule of the Internal Revenue Code. The creation of these rules allowed more flexibility for small business owners. To become a s-corporation one would have to incorporate under state laws and then elect to be taxed as a s- corporation with the Internal Revenue Service.

On the other hand, a LLC is an unincorporated association and it is formed under state law. A LLC could have one or more members. A LLC once formed can elect to be taxed as a partnership, corporation or s-corporation.

Advantages of LLC

While the s-corporation is a great structure to provide limited liability and asset protection, it comes with a few limitations. As a straight s-corporation shareholder, your interest in the business is an actual holding of shares. These shares are often personal assets in a lawsuit and subject to attachment by the courts. This means, that in a law suit the person suing you could obtain your shares and become an unwanted shareholder in your corporation.

Having a creditor with ownership of your shares is very undesirable and can be avoided by forming a LLC. The LLC entity is great for asset protection because of the charging order provision (check state law for application). What does this mean? This means the person suing only has rights to the distributions and not the member interest itself. Therefore, if the owner never pays out any distributions, the owner never gets any income.

Moreover, the creditor could be taxed on distributions that was never received. It would not take long for any creditor to realize that holding on to the judgment is not a wise idea.

Another advantage of the LLC is you get the flexibility of what kind of tax entity you will like to be. You could be taxed as a c-corporation, s-corporation or partnership.

Charging Order Example

If you think you will never get involved in a law suit, think again. People are taken to court for all kind of reasons like divorce, debt, auto accidents, unintentional side effects of your actions, just to mention a few. If you are taken to court, your business assets will be brought under the radar. It is your creditor’s lawyer’s goal to take all they can.

LLC Taxation: C Corporation, S Corporation or Partnership?

Now we know why we want a LLC over incorporation (the legal structure), what tax structure should we choose? That is, should you be a LLC taxed as a s-corporation or partnership? The answer depends on what you want to put in the entity. Corporations are bad structures for assets like real estate because of the problem of higher taxes when transferring your property.

Moreover, the main deciding factor in choosing between s-corporation and partnership is self-employment tax. Real estate is not subject to self-employment tax and so no money is saved by putting an asset like real estate in a s-corporation. Since there are no self-employment tax savings why not use the tax structure that will save you taxes in the long run.

To summarize, the advantages of the LLC are as follows:

  • Charging order protection
  • Tax savings on assets when placed in a partnership
  • More flexibility