Should you operate as an LLC?

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By: JIM VANDERSPEK - For the North County Times on March 27, 2005


Should you operate your small business as a Limited Liability Company (LLC) or as an S corporation?Ever since LLCs were permitted a few years ago, many new businesses have been told that it as a preferred choice. However, if you own a small business, you will probably find that setting yourself up as an S corporation is the way to go.

Here's why:

First, this choice will probably save you Social Security and Medicare taxes. In your S corporation, you can pay yourself a salary and issue yourself a W-2 at the end of the year. Only the amount on your W-2 will be subject to these taxes. Other profits, even if they are distributed, remain exempt.Since there is no limit on the amount of earnings that are subject to Medicare tax and the ceiling on earnings subject to Social Security taxes keeps rising, this is frequently the primary motive for setting up an S corporation.

However, one must not be too greedy when avoiding Social Security and Medicare taxes. The IRS is increasingly coming down on those S corporations which underpay their owner. As the pendulum swings to raising taxes again, this is one benefit that could be deemed a loophole. In fact, a proposal, which is gaining favor, would subject all profits from professionals who operate within S corporations to the taxes.

This result already exists for most small business limited liability companies. Since these are usually taxed as partnerships, Social Security and Medicare taxes kick in at full force.Another reason you may prefer using an S corporation is that it could work better as a way of protecting yourself from personal liability. In many cases this protection is the underlying reason for choosing either the S corporation or the limited liability structure. In our litigious society, there is a huge benefit in being able to isolate your personal assets from those in your business.

The difference is that the case law surrounding limited liability companies is very undeveloped. Each LLC is generally created by its own unique document. The chances are, in a serious lawsuit, that these organizing documents and other similar paperwork could be flawed or challenged.

In contrast, corporations including S corporations are fairly easy to set up and operate.It is less likely that your corporate structure will be successfully attacked.Finally, unlike virtually any other type of business, limited liability companies operating in California are subject to a tax on their gross receipts as well as being subject to a minimum tax. Paying taxes even when you are losing money can be especially distressing.

Both S corporations and LLCs are subject to a minimum California tax of $800. This could go even higher if you have high income. However, you will generally pay less in California income taxes as an S corporation.

Jim Vander Spek is a certified public accountant with offices in Escondido. Contact him at Jimv@vanderspekcpas.com.