In the previously mentioned business types,
all revenue would be taxed extra by the SECA tax. However, being
taxed like a S Corporation avoids all income requiring the extra tax,
overall allowing owners to reduce their tax expense. A company who
regularly earns a substantial amount of revenue may consider being
taxed like a corporation to avoid the SECA tax on part of the
generated revenue. However, LLC's with a single owner are almost
always taxed as a sole proprietorship and generally cannot claim S
Note: The IRS looks more closely at companies
that claim S Corporation status, in order to avoid abuse of the system,
because the salary/dividend split is somewhat subjective. For example,
if an owner of a LLC reports $20,000 as salary (subject to SECA Tax) and
reports $180,000 as dividends, then this owner will likely face major
problems with IRS. Conversely, $140,000 as salary and $60,000 as
dividends is a more reasonable split. The IRS considers illegal tax evasion to be very serious, so
it is better to be conservative to avoid significant consequences.
Less Government Regulation. One of the
downsides of corporations is high government regulation, which can
complicate management of the company due to numerous forms and rules.
While LLC's are still regulated, the level of regulation is
significantly less than for traditional corporations.
Unlimited Life. Like a corporation, a
Limited Liability Company is considered to be a separate entity from
the owners, which means that the company can continue to exist beyond
the lives of the owners. However, redistributing ownership of an LLC
is not as easy as it is for a corporation. Owners will need to fill
out special documents to redistribute ownership, whereas in a
corporation ownership is redistributed easily through the use of
buying and selling company stocks.
Note: For tax purposes, the
government does not consider an LLC to be a separate entity, which is
why it is possible to be taxed like a partnership.
Corporations are legally established
entities that are separate from their owners. Transferring ownership is
extremely easy through the use of buying and selling shares of stock
(i.e. shares of ownership). The primary benefit for a business to
become a corporation is to meet the financial needs of rapid growth
by acquiring significant financing.
Financial Strength. Whereas the financial strength of
a partnership is the financial strength of its owners, a
corporation's financial strength is completely separate from its
owners. Revenue earned can be partly distributed as dividends, but it is not uncommon for businesses to retain earnings for future growth. This financial strength is one of the characteristics of a corporation that
allows for significant funds to be raised much easier than for
Limited Liability. Corporations also have limited personal
liability to the owners, which was a unique benefit prior to the
existence of LLP's and LLC's. The most that an owner can lose is the
money he or she has invested into the company, even if the company's
debts exceed the invested amount in the event of bankruptcy. For
example, in a partnership, if the company owes a million dollars,
then the owners are responsible for repaying that amount even if the
owners have not contributed that much capital to the business.
However, in a corporation, if an owner has invested $10,000 in the
company, then the most he or she can lose is that investment: this is
the power of limited personal liability vs unlimited personal
Double-Taxation. Revenue is taxed as if the corporation
is an individual; and revenue can be used to reinvest in the business
for further growth, or it can be disbursed to business owners as
dividends. This taxation method results in revenue being taxed twice
when it is disbursed as dividends (the business entity is taxed and
then the dividends are taxed as individual income), which is one of
the drawbacks of corporations.
A S Corporation (Small Business
Corporation) is a special tax classification for any Corporation or
Limited Liability Company (LLC) that meets special characteristics,
including having less than one-hundred shareholders. This tax
classification allows revenue to be treated as it would in a
partnership, thereby avoiding the double-taxation of corporation
revenue. Money is viewed as passing directly to the owners, who then
report gains or losses on their individual tax returns.
money that is received from the company can be classified as either
salary income (i.e. "earned" income subject to the SECA
tax) or dividend income (i.e. "unearned" income). The
benefit of this strategy is to avoid double-taxation while
simultaneously reduce Self-Employment taxes (SECA Tax) since
"unearned" dividend income is not subject to SECA tax.
Note: Companies claiming S Corporation status are
scrutinized more heavily by the IRS, since the salary/dividend split is
subjective. As mentioned, an individual claiming $20,000 salary and
$180,000 dividends would likely face major consequences by the IRS. The
salary/dividend split is expected to be "reasonable;" and since the IRS considers illegal tax evasion to be very serious, it is better to error on the side of caution.
Further qualifications for the S
Corporation status are: a shareholding cannot be another company or
organization (except in certain cases), a shareholding cannot be
foreign, and the company cannot have more than one type of stock
(meaning there cannot be more than one way to define ownership).
Which is Better: Corporation or LLC?
With the flexibility of a LLC, one may
wonder why any company would still choose to become a corporation. The primary reasons why are:
- Corporations find
it much easier to obtain large amounts of financing,
liability is reduced with more shareholders,
- Ownership is
transferred more easily than in LLC's, and
- Being taxed as a
corporation is typically better when revenue earned is significant
due to avoidance of the Self-Employment SECA tax on all income.
Furthermore, for tax purposes, any LLC
with more than 100 shareholders is automatically considered to be a
corporation, even if the company is legally an LLC. So if the owners
of a company intend to grow their business into a significant
enterprise, then a corporation is likely the best business
classification to pursue.
Read more about Which is Better:
Corporation or LLC?
Business Entrepreneur: Build Your Own Online Business
How to Become a Millionaire or Billionaire