LLC vs S Corp? Scenarios when each is good fit!

When does it make sense for your business to be a Limited Liability Company (LLC)?  When is it better to be an S Corporation?

We have this discussion all the time with our clients and take them through a series of questions to help them find the right fit based on their goals and personal situation.

Below are some common situations...by no means an all-inclusive list, but situations where an LLC is best and situations where a S Corporation is a better fit.

The situations discussed below are based on generalized underlying tax benefits and costs that factor into the behind-the-scenes numbers for each entity type. This information is provided to be informational and not to be interpreted nor construed in any way as legal or personalized tax advice. 

When it's great to be an LLC

... Starting out in business and your annual profit is $50,000 or less a year?... an LLC is a great place to start out. You can always make the move to S Corporation when the numbers make sense.  

... Purchasing real estate property or have plans to move a real estate asset into an entity for some asset protection and liability coverage? Limited Liability Companies are a great vehicle for asset protection.

... Starting a Partnership with another individual that is not your spouse, a limited liability company or a limited liability partnership may be the best setup for you.  Each partner can always setup an S Corporation, and have the S Corporation own the interest in the LLC/LLP.   

Note: when involving partners, always bring in an attorney!

When it's great to be an S Corporation

... An individual is a sole-owner or a married couple are the only owners of a business, are US citizens, and profits are more than $50k per year.  It is great to be an S Corporation!

... A state-licensed professional that is not allowed to perform services under a LLC, can be a Professional Corporation and elect S Corporation status. These limitations vary by state but generally apply to accountants, doctors, dentists, and other state-licensed professionals.

... A limited liability company subject to the Gross Sales LLC fee in California may elect S Corporation status and pay less franchise taxes to California.  With gross sales over $250,000 in California, LLCs are subject to an additional annual fee...just to exist and do business in the state. When gross sales are over $500k or $1 million, the California LLC fees quickly escalate to $6,000 per year, just to be an LLC in California.  This quickly moves the needle to favor being an S Corporation even if net profits are under $50k per year.

When an S Corporation is not a good fit

... If a company plans to have employee stock options, obtain venture capital funding or will be operating internationally, a C Corporation is likely a better fit.

...Starting a side hustle and not sure when you will start bringing in income? A S Corporation will likely cost you more in setup and admin than any tax benefit you will see.  Start with an LLC and make the move to S Corporation when the numbers make sense.

... S Corporation tax strategies do not happen magically, they occur when a business owner drives and implements key strategies. If a business owner does not keep good books, is disorganized, and is not investing time or money into staying on top of their numbers, an S Corporation will add more admin, overwhelm and they will likely miss out on tax strategies due to inaction and procrastination.  I'm not calling this owner a hot mess, but if I were, a hot mess is not a good fit for a S Corporation.

... If a company is being set up for one year or a partial year...and plans to be closed, without goals of longevity... its intent is just to take advantage of S Corporation tax savings in one year...you are asking for an audit.

... An employee has heard that starting an S Corporation will allow them to write off personal expenses against their employee paycheck, and they have no business goals, or plans to generate business income or operate as a business. This is a no-go. Business income is needed to write off business expenses. Maybe it's time to start a side hustle and we'll revisit.

... Hiring kids on payroll who are under 18? S Corporations still have to pay Medicare and Social Security taxes even if the owner's kids are minors. There is a tax strategy to make this happen, by creating another entity that pays the kids, but the S Corporation is not that entity. 

For more information on this Hiring kids tax strategy, download our free Hiring My Kids guide or contact us to see how we can help you implement this scenario, have your minor kids working in your business, and not pay payroll taxes.

Why real estate and S Corporations do not mix

If you saw above, LLCs are a common way to hold real estate...and not S Corporations.  This is due to how real estate is taxed or not taxed when you sell or move real estate assets into and out of a company.

LLCs allow you to transfer your real estate in and out and no sale or gain is recorded. You transfer your basis and reassign ownership. It is not a sale.

S Corporations do not work this way.  Real estate moved out of an S Corporation is treated as a sale and is subject to capital gains tax, even if you are transferring title back to yourself, the only S Corporation owner. 

S Corporations are not typically used or recommended to hold real estate... except in very specific situations.  For example, this could apply to an entity that is in business to fix and flip properties and home sales are taxed at ordinary income tax rates and subject to self-employment taxes.

Tax Strategy vs Asset Protection

Working with professional advisors is key to building wealth.  Imagine seeing 4, 5 and 6-figure tax savings by simply being proactive and having a knowledgeable tax advisor and attorney in your inner circle.

This is doable and you don't have to be the 1% rich to have this trifecta!  

We provide tax strategies with clients and work closely with attorneys to help you build your power trifecta team that provides the best scenario for tax savings and asset protection.

The selection of entity type and timing of that entity, and/or tax type can include many factors.  That is why no blanket answer applies to all, one may or may not align with your personal goals. 

Define where you are going, what you want to do, and setup your entity from the beginning with your long-term goal in mind.  

Schedule a discovery call with us today to see what services are needed and how we can help you build more wealth, freedom and save taxes along the way!

Online tax savings calculator LLC vs. S Corp

Curious what your tax savings would look like if you converted from an LLC to a S Corporation in your state?

We use this online calculator and love it!  It is not ours and we hope the host never takes it down because it gives a graphical picture of all the shifting taxes... and what potential savings looks like between LLC and S Corporation.  With inputs, it provides a tax savings estimate based on the state the company is in. 

Note that it does not factor in costs but a tax differential.  To see more about what an S Corporation costs, read more at What does an S Corporation cost? Is it right for me?