S-Corp vs. LLC?: Find a (New) Lawyer.
Recently, I saw a blog post from a self-styled business lawyer purporting to compare LLCs and S corporations and help readers evaluate which is right for them. I found that post particularly frustrating because an LLC is a state law entity, and S corporation is a tax status: a business can be both.
When you form a business, you have two choices to make: you have to choose a state law entity and you have to choose a tax status. The world of state law entities is largely, but not entirely, separate from the world of tax status. In reality, these two choices are usually made together–the state law entity you choose will limit (but not necessarily dictate!) your tax options.
Choosing a State Law Entity
There are a variety of factors business owners should consider in making this decision.
Different states allow different types of entities. In Virginia, the usual business forms are Corporations (stock and nonstock), General Partnerships, Limited Partnerships, Limited Liability Partnerships, and Limited Liability Companies. Each type of entity is subject to different state laws. These laws affect how much asset protection the owners will have, what the initial and annual compliance requirements and fees will be, and (to some extent–see below) how the business will be taxed, among other things. There’s no “best” type of entity: the choice of an entity depends on the needs and goals of the owners and the business.
Choosing a Tax Status
Here’s a chart showing how state law entities usually match up with tax status. The solid green lines show the default classification, and the dashed green lines show what the business can theoretically opt into. The chart shows the rules that apply in many–but not all–cases. There are certain types of partnerships that have to be taxed as corporations, for example, and state law classifications do not control tax classifications.
You should definitely seek the advice of a lawyer before making decisions based on this chart!
Where might one find the official rules for this stuff?
The rules about the different entity types are in state law. Virginia’s State Corporation Commission website has useful information about Virginia business entities. The rules about tax status are in the tax code. Treasury Regulations §§ 301.7701-1 to -4 are a good place to start.
How does a business choose a tax status other than its default status?
The IRS has forms for this (Forms 8832 to elect to be treated as a corporation and 2553 to elect to be taxed as an S-Corporation).
What about sole proprietorships and informal business arrangements?
Sometimes, people on their own or with others conduct certain business activities without forming an entity. They might not even think of themselves as a business. Or maybe they’re trying to avoid being a business in any official way because they don’t want to have to deal with the additional paperwork. The tax code might still treat them as a business.Tags: business