S Corp vs LLC

[Deeprig9]

I'm about to incorporate into a business and I'm using legal zoom to do it instead of a lawyer. Most people that do what I do on the scale I do it are S corps, but they can't really tell me why. And the info on legal zoom is somewhat vague, but makes the LLC sound like the way to go.

 

Are any of you S Corps or LLCs and can tell me specifically why you chose one over the other?

 

 

Thanks!

[nat whilk II]

LLCs are chartered under State law, so there are variances between the States. Generally not huge differences, but they can make a difference here and there.

 

S Corps are purely a Federal invention.

 

S Corps have been around a lot longer than LLCs. The body of law for S Corps is therefore larger, more fleshed out, and there are more court cases and legislation to use as a guide. There are more uncertainties regarding LLCs.

 

S Corp upsides:

1. more guidance from courts and legislation

2. generally simpler than LLCs as far as tax law, liability law, etc

 

S Corp downsides:

1. can't get tax "basis" in the S Corp liabilities unless shareholder lends directly to the S Corp. This whole issue of "basis" is extremely complex. I won't even begin to try to explain it, but it's one of the foundation concepts of both S Corps and LLCs.

2. shareholders owning over 2% of the stock are treated less favorably

3. distributions of property out of a S Corp is valued at FMV.

4. IRS does not allow shareholders who spend out of pocket money on corporate business, unreimbursed, to take a deduction for those items on their personal returns.

5. shareholders who work for the S Corp MUST be treated as employees - payroll deductions for FICA/MEDI/Fed Inc Tax, pay the payroll taxes, issue W2s. If you don't do this, you are a sitting duck for extremely painful IRS treatment.

 

LLC upsides:

1. taxed usually as a partnership under federal law. This means more flexibility, more options in dealing with partners, ownership changes, elections, etc.

2. LLC owner/members get "basis" in partnership liabilities.

3. Out of pocket expenditures on behalf of the LLC can be deducted by the owner/managers IF authorized in the LLC/partnership agreement.

4. partners working for LLC don't have to be treated as employees (no W2, payroll taxes, etc). Can be paid via "guaranteed payments" (read IRS lit on this)

 

LLC downsides

1. lack of clarity in various aspects of the law

2. big uncertainty about whether LLC members are subject to federal self-employment tax on LLC income or not.

 

Overall, I'd say it's very much not a good idea to DIY when it comes to entity formation. I know, the DIY books tell you how easy it all is, save the attorney/CPA fees, etc. But there are SO many issues that can come back and bite you in the butt. Examples:

 

1. is there a State-level franchise tax to deal with?

2. are you in a community property state? This effects the paperwork even if the spouse has nothing to do with the business.

3. will you have sales & use tax to deal with? Out of state sales? Out of the country sales? A thicket of issues here.

4. do you understand employment law well enough to stay in compliance?

5. how to pension plans (IRAs, SEPs, SIMPLEs, 401(k)s) work in the context of your chosen entity?

6. how is health insurance for owners handled in your chosen entity?

7. What are the formal procedures you need to go through on a periodic basis in order to maintain the liability protection afforded by your chosen entity?

8. what happens if you sell a share of your business? Or give a share to someone else?

9. what are the related-party rules and how will they effect your business?

10. what happens to your business entity if you die unexpectedly?

11. will you have a clue as to how to keep the books in a way that maintains compliance with state and federal tax laws?

12. do you know how to actually issue shares in a corporation? Or what documents that establish ownership in an LLC?

 

it goes on and on and on

 

My advice is usually, for smaller business - go with the S Corp. Mainly because the law is more stable, because compliance with payroll taxes is enforced, and tax preparation is generally simpler ('tho not exactly "simple"). Most business owners see the enforced payroll tax issue as a bummer - I see it as a way to keep the business out of trouble.

 

LLCs are "fancier" - lawyers like them. That tells you something about them - lawyers love legal ambiguity for obvious reasons. There will be changes in the LLC laws as various issues get hammered out at the state and federal levels. You'll have to stay informed. I recommend LLCs for businesses that have complex dealings between partners. Also for sole proprieterships just looking for some liability protection but no federal tax angles. Because a single-member LLC is disregarded for federal tax purposes - it's just treated as a sole proprietership filing Schedule C.

 

Every DIY corporate/partnership formation I've ever seen misses some important element. It's your choice....

 

nat whilk ii

[Deeprig9]

I like the idea of sole propriety for tax purposes, with the personal liability protection of an S-corp. That's what piqued my interest. My business would end up with 5 or 6 employees at the most, any bigger than that and I would definately hire a lawyer and reformat. I'm familiar with the worker's comp law in my state and to hold my license I need $1 million liability policy anyway in case I get sued, so liability isn't my real concern. Taxes are, at this point. I want the lowest taxes possible.

 

I hope this isn't too off-topic, my company isn't a music related business, but alot of the same issues do apply, so I hope this doesn't get deleted or moved. I like the professionalism of this particular forum, relative to some of teh* others.

 

Thanks!

[Dreabfly]

I would try to weigh the additional costs of incorporation before going this route definitively. Between the fees to inc., accountant costs, possible attorney fees, and extra time spent in paperwork, it may be that remaining a sole proprietorship will make more sense financially.

 

My band was a general partnership. It's a simple enough format, but we were also lucky in that we were old friends who went in with a very down to earth attitude about the business. We didn't even have a partnership agreement drafted, which I would not say would be wise for most people. There were a lot of additional costs that didn't help in our business journey because we chose that path. In retrospect, I would have made us a sole prop with one employee - it likely would have saved us a lot of money - and saved me many many many hours in lost time learning about business crap that stole valuable energy from our work.

 

Most of the good books I've read about incorporating all say you should only consider it once you're making some good money. If you're still in start-up or struggle mode, it may just be more than you need to tackle at the moment.

 

As for the particular format you should choose, I would definitely consult a live attorney. My experience with all the business stuff was that DIY books and articles make this sound like it is all so incredibly easy, when there are in fact, a lot of things you need to know to do it correctly.

 

I see the DIY business community as another "sell the dream" scam. They make tons of money selling the idea of quick and dirty business setups that allow you to build your dream business with little risk doing everything yourself.

 

If you want to make sure your business has a chance at survival - get good professional advice about what will meet your business needs and the actual costs associated with it.

[Deeprig9]

Ideally I would operate as a sole proprietor, as a band, that's how we operate, individual sole proprietors, but my business requires people on ladders around electricity and travel and dangerous things, I need a corporate veil. I don't want a situation where Bubba slips and falls and takes my strat to pay for his "emotional damage".

[Woodcs82]

Im no expert, but i would say operating as a sole proprietor is your worst bet. You aren't protected as a sole proprietor. How can a group be a sole proprietor anyways? Just curious, like i said im no legal expert... LLC's protect your personal property, that is one big advantage.

 

Colin

[Dreabfly]

 

Im no expert, but i would say operating as a sole proprietor is your worst bet. You aren't protected as a sole proprietor. How can a group be a sole proprietor anyways? Just curious, like i said im no legal expert... LLC's protect your personal property, that is one big advantage. Colin

 

 

You can be a sole proprietor and have employees - so the person who is actually leading would be the business owner and employ everyone else. I was an employee under this setup - of a very successful estate planner in LA who operated his business as a proprietorship and made close to half a million dollars a year. It was just cheaper and easier for him to deal with. You can also hire contract employees and 1099 them for their income, escaping the necessity of paying employment taxes.

 

You buy insurance policies to cover liability. Yes, of course, you could still be sued - but everyone can be sued, even if you're an LLC or a corporation.

 

The question is whether you are choosing a business model bigger than your business - only a good advisor can tell you that.

 

Musicpro insurance now sells a bunch of products for musicians, including (I think, but I can't check right now because they are updating the site right now this second) tour insurance. You might want to check if they have any products that would help with the liability part.

[Woodcs82]

OT: Do you like LA?

[Dreabfly]

 

OT: Do you like LA?

 

 

I'm an LA native. In my heart I love LA. But it has become a city totally out of control. The cost of rent/property is outrageously expensive, and the traffic has become pure insanity. We pay so much more for gas/energy/food/clothing than anyone else in the country, while wages have pretty much stagnated. It's getting harder and harder to just live here. And the music industry and broadcast industry are not doing so great, which has hit this place like a ton of bricks.

 

There are a lot of clubs to play in, which was always an upside for me as a musician, but there's no pay and lots of competition. Lots of musicians in many different ability ranges. Everybody wants to be a star, which makes for strange dynamics and a lot of difficulty at first making friends. You have to weed through people for friendships and band members, which after awhile you get pretty good at.

 

The things I love about LA: great weather, great mountain biking, the beach, gorgeous summer nights, great concerts, tons of healthy eating restaurants, lots of artists in all kinds of art (most of them starving, but love to share their talent and collaborate).

 

I'll be leaving soon because of the cost of living, which is a song a lot of people are starting to sing around here lately.

[daddymack]

 

I'm an LA native. In my heart I love LA. But it has become a city totally out of control. The cost of rent/property is outrageously expensive, and the traffic has become pure insanity. We pay so much more for gas/energy/food/clothing than anyone else in the country, while wages have pretty much stagnated. It's getting harder and harder to just live here. And the music industry and broadcast industry are not doing so great, which has hit this place like a ton of bricks. There are a lot of clubs to play in, which was always an upside for me as a musician, but there's no pay and lots of competition. Lots of musicians in many different ability ranges. Everybody wants to be a star, which makes for strange dynamics and a lot of difficulty at first making friends. You have to weed through people for friendships and band members, which after awhile you get pretty good at. The things I love about LA: great weather, great mountain biking, the beach, gorgeous summer nights, great concerts, tons of healthy eating restaurants, lots of artists in all kinds of art (most of them starving, but love to share their talent and collaborate). I'll be leaving soon because of the cost of living, which is a song a lot of people are starting to sing around here lately.

 

Amen to that...I've been in L.A. for over 35 years, but I'm not planning on leaving until I retire, at which point, the C.O.L. will make this place impossible. For now, the pluses outweigh the negatives, and my family is mostly here.

 

Dreabfly, if I may ask, what part of LA is your hat hanging in, and where would you want to go?

[Dreabfly]

Amen to that...I've been in L.A. for over 35 years, but I'm not planning on leaving until I retire, at which point, the C.O.L. will make this place impossible. For now, the pluses outweigh the negatives, and my family is mostly here. Dreabfly, if I may ask, what part of LA is your hat hanging in, and where would you want to go?

 

I live in the city - Just south of Museum Row (the Wilshire district). My family left about 5 years ago, and now the game is about trying to get closer to them yet still be in a city that I think I'll enjoy living in.

 

There is a very real possibility (I found out this week), that we are moving to Vegas - the upside of which would be maybe (fingers crossed) there would be work for an aging singer/guitarist like me. At least homes there are affordable and there is no state tax. But oy, the heat. I think I'll be doing a lot of hiding in my studio.

 

In a way, it's really sad to be forced to leave. I just never saw that coming (which I think is true for a lot of other people here).

 

But the times they are a-changin'.