LLCs are Not Always A Good Fit

Author: Derek S. Underwood, Esq.

We often incorporate businesses for our clients. Although LLCs are very popular, they may not always be the best choice for a small business with a single owner.

As a business structure, a Limited Liability Company (LLC) certainly has its advantages. It provides protection for its members while allowing for extremely flexible ownership, membership, and operation. In addition, it provides a means for the transfer of certain assets to and from its owner with limited or no tax consequences.

However, for some small businesses, an S corporation may be a better choice. The S indicates a type of corporation allowed by the Internal Revenue Service where the corporation, itself, does not pay taxes. Instead, its profits pass through to its owners, based on their respective shares of ownership, and are reported on their individual tax returns as S corporation income.

In the case of the single business owner with an LLC, he or she is required to pay self-employment tax on the LLC income, just like a sole proprietor. In contrast, the single owner of an S corporation does not pay self-employment tax on the income of the corporation, as long as the owner also receives a reasonable salary from the S corporation.

For example, if the business has an annual profit of $100,000.00, and if it is formed as an LLC, its single owner will be assessed self-employment tax on the entire profit of $100,000.00. In contrast, if the business is an S corporation, and the single owner receives a reasonable salary of $50,000.00, the remaining $50,000.00 passes to the owner free and clear of self-employment tax. It is still part of the owner’s gross income, but at least it is not subject to the self-employment tax.

The federal self-employment tax rate for 2007 is approximately fifteen percent (15.3%) on income up to $97,500. The self-employment tax on any additional income beyond $97,500.00 is approximately three percent (2.9%).

Besides possible tax advantages, an S corporation is usually less expensive to initially form. So, before jumping to an LLC, check with your attorney and your accountant to see if an S corporation might be a better choice for your particular circumstances.

About the Author
Derek S. Underwood, Esq. is an attorney with Colman & Underwood.