It seems like every day a client will ask me which is better an LLC or an S-corp. The answer is there isn’t an absolute answer because it depends on each situation. It depends on what are you going to use it for, whether or not there will be other owners, what state are you in, so and so forth. It can also be a false choice because depending on the situation, someone might need both!
LLC or S-Corp: Which Fits Your Needs?
Forgive my golf analogy, but I like golf. Asking if an S-corp is better than LLC is like asking if a putter is better than a driver. It depends on the situation. A putter is an absolute necessity when you’re on the green, but it doesn’t make any sense to use a putter when you need to drive the ball a long distance. A driver is great when you need to hit the ball a long distance, but it doesn’t make any sense to use a driver when you’re on the green. Your tax and legal structure might not be exactly like your golf buddies’ tax and legal structure because your facts and circumstances might not be exactly the same as theirs. An LLC and an S-corp are each important ‘tools’ in the ‘golf bag of life’ to be utilized when the time is right.
When is an S-Corp the Better Choice?
As a general rule, an S-corp is great for a small business that provide services or sales, but is not the best option for owning a rental. An S-corp is all about saving you from getting ‘killed’ in Self-employment taxes. So if you’re not paying ‘through the nose’ in self-employment taxes in your small business (maybe it’s a side hustle as an example, or it is a brand new business not making much money), you can have an S-corp if you want, but you don’t absolutely need one. For some folks, it’s all about timing and personal preference. Maybe their business is new and they have no idea how much they’ll make, etc. In this situation, a smart thing to do as a small business is to start out with a ‘regular’ LLC, and then when the time is right, you could make an S-corp election, effectively turning your LLC into an S-corp for tax purposes.
Why Choose An LLC for Rental Properties?
As a general rule an LLC is better than an S-corp when it comes to owning a rental property. With a rental property, you want to protect yourself legally, which an LLC provides. An LLC is also great because it doesn’t get in the way of many of the inherent tax benefits that come from owning a rental property. Long story short, an S-corp is not an ideal option to own rental real estate.
Can You Have Both? Using LLCs and S-Corps Together
For folks who have a small business AND they own rental real estate, they likely need an S-corp AND an LLC, they might need both! Just like if you’re playing ‘real’ golf (unlike mini golf or Top Golf), you need a putter AND a driver!
Understanding Entity Taxation: LLC vs S-Corp Explained
It’s worth noting that part of what can be confusing in this debate is the terminology used. For the folks who like to geek out on this topic, hopefully you’ll enjoy this paragraph – for the rest of you, you can skip this paragraph. By way of context, an S-corp is just a tax election. When your entity is filed with the state, it’s by default either a corporation / Inc., or it’s an LLC. In both situations, whether forming a corporation or an LLC, the owner gets the benefit of limited liability. Although there are other entity entity types (LP, LLP, PC, PA, PLLC, etc) for most folks it’s either going to be a corporation/Inc. or an LLC. By default, a corporation/Inc. is taxed as a C-corp, unless an S-corp election is made. Most big businesses you’ve heard of are C-corp’s. By default, an LLC owned by one owner is taxed as a sole proprietor whereas an LLC owned by more than one owner is taxed as a partnership. These default rules will remain unless a different tax election is made (like being taxed as an S-corp). As a general rule, if you’re going to have partners/co-owners, whether it’s to own rentals or start a business, a partnership LLC is likely your best bet (no S-corp election). In other words, telling someone you have an LLC tells them absolutely nothing about your entity is actually taxed.
It is crucial to understand that an S-corp can be an LLC taxed as an S-corp. I’m sorry if that doesn’t make sense but it’s true. As was explained above, when someone has an S-corp, it could be an LLC taxed as an S-corp. For my clients that are small business owners providing services or selling products, a lot of them are an LLC taxed as an S-corp. For the tax people in their lives like their Tax Attorney, their CPA, etc. it’s an S-corp. But for their customers and other third parties, it’s an LLC because LLC is in the name. For example, say I have a client who has a business called “Don’t Hit It In The Lake”, LLC and it’s doing very well financially and is my client’s main source of income. It will almost certainly be taxed as an S-corp (to save on taxes) meaning at some point an S-corp election was made and filed on the LLC. So is “Don’t Hit It In The Lake” an LLC? Yes. Is it an S-corp? Yes.
Final Thoughts
A few general rules have been laid out here for you to help you get a better ‘lay of the land’, but if you should know one thing about tax and legal matters, the general rules are just that, there can be exceptions to the general rules, and sometimes there are exceptions to the exceptions. If you’re a small business owner or a real estate investor (or both!) don’t do this yourself, let the professionals help you. A competent professional won’t sell you a bunch of LLC’s or entities you don’t need. They will custom tailor a plan for you that provides you the appropriate amount of tax planning and asset protection planning to meet your needs. Once they understand the specifics of your situation, the answer of what you need should be clear.
Not sure which structure fits your business? Contact KKOS Lawyers for a custom strategy – schedule your Comprehensive Tax & Legal Consult today!