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S Corporation or LLC before purchasing a franchise? Which…

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S Corporation or LLC before...
S Corporation or LLC before purchasing a franchise? Which has best tax advantages?
Submitted: 3 years ago.Category: Tax
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6/10/2015
Tax Professional: Tax.appeal.168, Tax Accountant replied 3 years ago
Tax.appeal.168
Tax.appeal.168, Tax Accountant
Category: Tax
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Experience: 3+ decades of varied tax industry exp. Tax Biz owner
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Welcome. Thank you for choosing us to assist you. My name is ***** ***** my goal is to help make your life, a little... less taxing.
While both entities are popular, it really depends on the business owner. A business owner should consider operational ease, administrative requirements, profit-sharing and employment tax implications when deciding.
Following is a list of pros and cons of both:
Pros and Cons of the LLC
One of the features that distinguishes the LLC from an S-Corp is its operational ease. There are far fewer forms required for registering and there are fewer start-up costs. Filing taxes is a once-a-year affair on April 15: a single-member LLC files a 1040 and Schedule C like a sole proprietor; partners in an LLC file a 1065 partnership tax return like owners in a traditional partnership. Moreover, LLCs are not required to have formal meetings and keep minutes.
There are also fewer restrictions on profit-sharing within an LLC as members distribute profits as they see fit. Members might contribute different proportions of capital and sweat-equity. Consequently, it's up to them to decide who has earned what percentage of the profits or losses.
But LLCs are not the perfect entity for all businesses. First, an LLC has a limited life: when a member dies or undergoes bankruptcy the LLC is dissolved. Typically, you would determine in advance the length of the LLC's duration when you file it with your state. If your plans include taking your company public or issuing shares to your employees, essentially prolonging its life, then you would need to convert to a corporate business structure.
Second, the owner of an LLC is considered to be self-employed and must pay the 15.3% self-employment tax contributions towards Medicare and social security. As such, the entire net income of the LLC is subject to this tax. It costs money to have some operational ease!
The IRS also limits the 'characteristics' of your company. An LLC may only have two of the four characteristics that define corporations: 'Limited liability to the extent of assets, continuity of life, centralization of management, and free transferability of ownership interests.' Therefore, if you wish to have more than two of these characteristics, you'll need to convert to a corporate business structure.
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Pros and Cons of the S-Corp
One of the best features of the S-Corp is the tax savings for you and your business. Recall that members of an LLC are subject to employment tax on the entire net income of the business. Conversely, only the wages of the S-Corp shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a 'distribution' which is taxed at a lower rate if at all!
As I mentioned before, the shareholder must receive reasonable compensation. If you try to cheat the system by paying yourself a lower salary and higher distributions you might get a tax advantage for the year, but the IRS takes notice of such red flags. If they reclassify your distributions as wages you'll be back to paying the higher employment tax and you will have the IRS's attention. Need I say more?
Keep in mind that some benefits that shareholder/employees receive can be written off as business expenses. Nevertheless, if such an employee owns 2% or more shares, the benefits like health and life insurance are deemed taxable income.
An S-Corp also allows the business to have an independent life separate from the shareholders. If a shareholder dies, leaves the company, or sells his or her shares the S-Corp can continue doing business relatively undisturbed. By maintaining the business as a distinct corporate entity, clearer lines are defined between the shareholders and the business that improve the protection of the shareholders
The tax savings and solidity of the S-Corp also come with a price. As a separate structure, S-Corps require scheduled director and shareholder meetings, minutes from those meetings, adoption and updates to by-laws, stock transfers and records maintenance.
In addition to all of this paperwork are the tax forms required by the IRS. Such forms include:
Form 1120S: Income Tax Return for S Corporation
1120S K-1: Shareholder's Share of Income, Credit, Deductions
Form 4625 Depreciation
Employment Tax Forms
Form 1040: Individual Income Tax Return
Schedule E: Supplemental Income and Loss
Schedule SE: Self-Employment Tax
Form 1040-ES: Estimated Tax for Individuals
Forms 2553, 941 and 940
These forms are due at various times during the year, so the burden to file them increases.
Also, states do not treat S-Corps equally. Most recognize them similarly to the federal government and tax the shareholders accordingly. However, some states like Massachusetts tax S-Corps on profits that rise above a specified limit. Other states don't recognize the S-Corp election and treat the business as a C-Corp with all of the tax ramifications. And if that isn't enough, some states like New York and New Jersey tax both the S-Corps profits and the shareholder's proportional shares of the profits! It pays to do your homework.
REFERENCE SOURCE:
www.sba.gov/blogs/should-my-company-be-llc-s-corp-or-both
The blog found at the following link should also be helpful to you.
http://www.bizfilings.com/learn/llc-vs-s-corp.aspx
Let me know if you require further assistance with this matter.
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