Tax Comparison Between Corporations And LLCs
Depending on the nature of your business, there are distinct federal tax advantages and disadvantages between establishing a partnership, corporation and a limited liability company. Before determining the right entity for your business, get legal advice from an experienced tax lawyer.
Federal Income Tax Advantages Of Subchapter K (Partnerships) Compared To Subchapter S Corporations
- There are no eligibility or election requirements to meet in order to take advantage of Subchapter K for partnership tax treatment. Corporations must meet onerous requirements to qualify for Subchapter S tax treatment.
- Subchapter K can provide for special allocations (Section 704(a)) among partners. Subchapter S requires each shareholder to be treated the same, eliminating some tax planning strategies.
- Under Subchapter K, a partnership basis may be included in the partners’ bases in their partnership interests. Shareholders of S corporations can only include in the basis of the stock amounts they lend to their corporation.
- Distributions of assets from Subchapter K are generally tax-free. Distributions of assets from S corporations are treated as sales of those assets and can trigger gain or loss.
- When a partnership redeems a partner, the other partners get an inside basis step-up. When an S corporation redeems a shareholder, there is no inside basis step-up at the corporate level.
- When partners sell their partnership interest to other partners or to third parties, the buyers get inside basis step-ups. When shareholders of S corporations sell their stock to other shareholders or to third partnerships, the buyers don’t get inside basis step-ups.
- Partnerships can grant partnership interests to existing and new partners in exchange for past or future services. S corporations cannot.
Federal Income Tax Disadvantages Of Subchapter K As Compared With Subchapter S
- Sales of interests in partnerships can trigger ordinary income treatment for the sellers with respect to ordinary income assets. Not so for sales of Subchapter S stock.
- Partnership contractual arrangements, e.g., concerning options to purchase partnership interests and grants of restricted partnership interests, can involve complex and expensive specialized drafting and may raise issues to which there is no clear answer. S corporation grants of stock options and restricted stock don’t usually involve complex drafting or unresolved issues.
Reasons To File As An LLC But To Be Taxed As S Corporation
An LLC taxed as an S corp is the same as a straight S corp. In addition to being a shareholder, the owner-officer of an S corp who performs services on behalf of the S corp is considered to be an employee of the S corp.