Limited liability companies (LLCs) are one of the newest types of business entities. Like corporations, they offer many benefits over partnerships and sole proprietorships. Whether an LLC or a corporation is better for a small business depends on the type of business. The best comparison here is between an LLC and an S corporation, because an LLC can choose to be taxed as an S corporation.
Social Security Taxes
The owners of the S corporation can take out some profits without Social Security taxes. For a large business in which the owners take out salaries of $118,500 or more plus profits, there would not be much difference, since the Social Security tax cuts out at that level as of 2015. However, for a smaller business, in which an owner could take out a $30,000 salary and $20,000 profit, the extra taxes on the $20,000 would be over $3,000.
If a corporation plans to go public or sell stock to a large group of people, the corporate stock might be easier to sell than membership interests in the LLC.
An important advantage of an LLC is that in some states, a creditor cannot collect the members’ LLC distributions. With a corporation, creditors cannot collect a shareholder’s personal assets, but can collect the shareholder’s dividends.
Profits, Losses, and Taxes
The other advantages of LLCs are found in certain tax situations. For example, an LLC can make special allocations of profits and losses among members, whereas S corporations cannot. S corporations must have one class of ownership in which profits and losses are allocated according to the percentage ownership. In an LLC, money borrowed by the company can increase the tax basis (and lower the taxes) of the owners, whereas in an S corporation, it does not. Contributing property to set up an LLC is not taxable, even for minority interest owners, whereas for a corporation, regulations only allow it to be tax free for the contributors who have control of the business.
The owners of an LLC can be foreign persons, other corporations, or any kind of trust, whereas the owners of S corporations cannot. An LLC may have an unlimited number of members, while an S corporation is limited to one hundred.
LLCs are also popular because of their flexible management options, allowing owners to directly managed the business or have others handle the day to day operations. LLCs have fewer formalities than corporations, another advantage for some business owners.
Corporations offer a greater variety of fringe benefit plans than any other business entity. Various retirement, stock option and employee stock purchase plans are available only for corporations. Plus, sole proprietors, partners and employees owning more than 2% of an S corporation must pay taxes on fringe benefits (such as group-term life insurance, medical reimbursement plans, medical insurance premiums and parking). Shareholder-employees of a C corporation do not have to pay taxes on these benefits.