S CORPORATION AND LLCS
Commonly known as LLC, a Limited Liability Company is an incorporated association tasked with providing limited liability to its members (owners). The company’s members are generally not personally liable for its Debts, Obligations, or Liabilities.
Also, the owners are allowed to be part of the managing activities and control of the company, without exposing themselves more than they are required to. Like corporations, Limited Liability Companies are formed by filing an organization certificate with the Commonwealth secretary and thereafter, paying a fee.
In case you were wondering how Limited Liabilities Companies operate, they do function under the operating agreement terms, which is a document that’s comparable to a partnership agreement. It’s also imperative we note that LLCs file annual reports with the Commonwealth Secretary.
What’s the difference between the LLC and LLP
As you can already tell, an LLP is a partnership that limits a partner’s personal liability just by registering with the Secretary of the Commonwealth. The partner will be limited in Debts, Obligation, or Liabilities. In a Limited Liability Partnership, a partner is not permitted to eliminate liability for his or her own negligence. They are also limited whether in contract, tort, or otherwise from errors, omissions, negligence or wrongful acts.
Classification for Massachusetts income tax purposes
These two companies are classified the same way for Massachusetts tax purposes as they are for federal income tax purposes.
For Massachusetts income tax purposes, a single-member Limited Liability Company won’t be regarded as an entity that’s separate from its owner, if it’s not regarded for federal tax purposes.
If they have been treated as a partnership for Massachusetts income tax purposes, An LLC or an LLP with more than two members will be treated the same way for federal tax purposes. The same principle applies in a situation where they are treated as a corporation.
The S corporation
We’ve already established that a single-member Limited Liability Company gets taxed as a sole proprietorship while multiples are considered a partnership. However, if the LLC were taxed as an S corporation, that would mean that the owner’s salary would be treated as a business expense. This also means that they need to report the salary together with other business profits on their personal income tax return.
Shareholders in an S corporation can be individuals or organizations and businesses. Firms considered S corporations for federal purposes are treated the same way for Massachusetts purposes.
One other thing that’s important to mention is the fact that the entity’s income, losses, and different deductions are always passed through the various shareholders, and often reported and taxed on the individual returns.
Advantages of S Corporation
- There’s limited liability for shareholders and management.
- In addition to the unlimited number of management, there are no state residency requirements.
- You can protect yourself from personal liability using a distinct, court-recognized existence. So if you’re smart, you won’t have to lose your personal wealth in assets like a car, home, or nest egg.
- Flow-through taxation: after the profits have been equally distributed to the shareholders, they’ll be taxed on a personal level.
- There’s incredible privacy protection.
- A great income-splitting potential for employees/owners.
- Only entities that offer consultative services can operate effectively as S Corporations as they don’t have significant start-up costs or heavy machinery.
Disadvantages of the S corporation
- The shares are all subjected to seizure and sales at the shareholder level, in a court proceeding.
- There is a maximum limit on the number of shareholders the company should have, and the shares have to be held directly.
- Tax-free benefits are only given to employees holding two or more percent of the firm’s shares.
- Due to the fact that flow-through taxes are paid at a personal rate, high-income shareholders often find themselves paying more on their distributions.
- Control is ultimately on the stockholder’s hands, so it’s not suitable for an estate planning vehicle.
- It’s really not suitable for holding appreciating investment. The capital gains tax that you end up paying after selling your assets will incur high taxes compared to those paid by LLCs.
- Limited to one class of stock.
The primary benefit of S Corp taxation is that the corporation’s shareholders don’t have to worry about paying the self-employment tax on their business profits. They only get taxed on the salaries that they earn. However, there’s a catch. Before considering the profits, every owner who is also an employee has to pay a “reasonable” amount as compensation, subject to Medicare and Social Security Taxes.
Ash CPA offers complimentary consultations. Contact our team to learn more about LLCs and S Corporations. We have over 20 years of experience assisting business of all sizes and industries. Call (617) 462-6651 or book an appointment online.