Question

Does the creation of the LLC make the S Corp obsolete? Why or why not?

Answer 1

A business structure, in terms of the legal entity you choose for our business, significantly impacts some important issues in our business life. These issues include the exposure to liability, and at what rate and manner we and our business are taxed. We should be aware of some of the differences in business formation, especially when choosing between an LLC or S corporation for your business.

With a default LLC, all company profits pass through to the owners’ personal tax returns, and then the owners must pay income tax and self-employment tax on the entire amount.

With an S corp classification, owners pay income tax and self-employment tax on a predetermined salary. Any profit distributions are only subject to income tax.

Most small businesses file taxes under the default LLC tax classification. This is because small businesses don't usually carry over the amount of profit required to make the S corp tax designation beneficial.

Many LLCs will benefit most from the default LLC tax classification. LLC owners often put any profit back into their small businesses each year to promote growth. And without profit and distributions, there's no basis for electing an S corp.

The default LLC tax structure is best suited for businesses with these characteristics:

• Their owners reinvest profit back into the business to promote growth
• The cost of bookkeeping and payroll services would outweigh the tax benefit of an S corp.

Should LLC make the S Corp obsolete?

Whether or not an LLC should elect S corp status depends on how much profit the business is going to earn and carry-over from tax year to tax year.

Generally, if you know your business is going to have an annual distribution that is greater than $10,000 after paying yourself a reasonable salary, then your business has enough profit to justify becoming an S corp.

If you are unsure how much profit the LLC will make or if you want to reinvest the profits back into your LLC, it’s best to remain in the default LLC classification with the IRS. You can apply for an S corp status when it better suits your business.