I am frequently asked about the differences between LLCs and S Corporations, and the advantages and disadvantages of both types of entities. This guide is a follow-up to the guide on the advantages and disadvantages of Colorado LLCs.
Advantages of S Corporations
1. The sections of the Internal Revenue Code that impose employment taxes distinguish between general and limited partners but do not address how members of LLCs should be treated. The IRS has had proposed regulations to deal with this problem for twenty years, but has not finalized the regulations, perhaps because of criticism when they were first proposed in 1997. Although IRS personnel have stated in public forums that they will not object if taxpayers report on the basis of the proposed regulations, the proposed regulations in many cases will not provide a good solution for members of LLCs, particularly LLCs that provide services.
2. In an S corporation, salary paid to an owner-employee is subject to employment taxes. Any profits of the S corporation allocated to the owner-employee over and above the owner*s salary are not subject to employment taxes.
3. In some cases taxpayers have made an S corporation election and allocate a small amount per year to salary and take the balance as allocated profits. Such an action will spark IRS interest and likely lead to a reallocation of the split away from an overly-aggressive position of the taxpayer. The taxpayer may still come out ahead, however.
Disadvantages of S Corporations
1. Limits on number and type of shareholders.
2. Can have no more than one class of stock except may have non-voting stock. Economic rights of each share, voting or non-voting, must be equal.
3. Corporate formalities apply.
Additional resources provided by the author
For additional information on the matters addressed in this guide, please contact Adam Aldrich at Aldrich Legal, LLC
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