Corporate Law: LLCs can provide favorable tax benefits

Stephen F. Aton is a Springfield attorney practicing in the areas of corporate law and taxation and estate planning.

The limited liability company has been a viable option for establishing a new business for approximately 10 years.

A primary advantage of the LLC is that owners receive the same liability protection as shareholders of a corporation. Another attraction of the entity has been that the company is taxed in the manner of a partnership. But some businesses have declined to utilize the LLC because the dividend distributions of a corporation are not subject to the self-employment tax. A company may, however, organize as an LLC and elect S-corporation taxation, with the same favorable dividend tax treatment.

A regular, or C-corporation, is subject to double taxation. The entity pays tax and then the shareholder pays tax on earnings distributed as dividends. By electing to be taxed as a sub-S corporation, an LLC may be taxed as a partnership.

With a partnership, as with an LLC electing to be taxed as an S corporation, the entity itself is not taxed, and all income and deductions flow through to the owners in proportion to their ownership interest.

For example, if an LLC had net earnings of $100,000, and was owned equally by four people, each would report $25,000 on their personal tax return. The entity would file an informational return but pay no tax.

Some businesses have chosen to be incorporated as S-corporations rather than LLCs because they can distribute some of the profits of the company as dividends, which are not subject to self-employment tax. With the self-employment tax at 15.3 percent, you could realize significant tax savings are possible.

Another option is to organize the business as an LLC and then elect to be taxed as an S-corporation. The Articles of Organization filed with the state allow you to elect corporate taxation. You may also elect corporate tax status on the federal level by a filing with the IRS. After filing the entity classification election, you would then file an S-election to make your LLC be taxed in the manner of a partnership.

There are significant advantages to structuring a business as an LLC taxed as an S-corporation, rather than as a standard S-corporation. First, the LLC has no officers or directors to appoint. Nor must an LLC have annual meetings and minutes. Moreover, almost any person or entity is a permissible owner of an LLC, while permissible S-corporation shareholders are more highly restricted.

In addition, a corporation must file an annual report with the Secretary of State and may be dissolved for failure to do so. The LLC is not required to file the report. The LLC is generally more flexible and subject to fewer rules and regulations than a corporation, making it easier to administer. And by electing S-corporation tax status, the LLC is able to obtain the same favorable tax treatment of dividends as the corporation.

While the benefits of an LLC taxed as an S-corporation are great, it is not appropriate for all businesses, and conversion to an LLC of an existing entity may trigger tax liability. Before making a decision, consult with your tax professional to see if the entity is best for your business.