LLC vs. S Corp

If you are planning to start a new business, the first issue to consider is the entity under which to operate the business. One has unlimited liability when operating a business as a sole proprietor.


All states now have enacted LLC statues, which provide that members of an LLC will not be personally liable for the debts of the entity, and liability is limited to the members’ capital contributions. An LLC with two or more members are treated as a partnership unless the LLC elects to be treated as a corporation. When an LLC has only one member, the fact that it is an LLC is ignored or disregarded for the purpose of filing federal taxes. You report income and expenses on Form 1040 Schedule C, E, or F. For California taxes, you still need to report total income on Form 568 to pay LLC fees. LLCs are subject to an $800 annual tax if they are doing business in California. Also, in California, every LLC must pay a fee based on total income, which can range from $0 to $11,790. For total income of up to $250,000 there is no LLC fee. In the Northwest Energetic Services, LLC vs. FTB case (April 13, 2006), the San Francisco Superior Court ruled that the LLC fee is unconstitutional because it really is a tax and not a fee. The FTB has appealed the decision.


If you decide to operate as a corporation, then you need to evaluate whether to operate as a C corporation or an S corporation. C corporation can select a fiscal year-end and is able to use a lower corporate tax rate. However, double taxation applies when earnings are distributed as dividends. If you elect to be an S corporation you can avoid FICA taxes on K-1 distributions, use calendar year-end, and avoid double taxation. In general, an S corporation does not pay any income tax. You use Form 2553 to make an S election.

The election of S corporation status must be made by a qualified corporation, with the unanimous consent of all the shareholders on or before 15th day of the 3rd month of its tax year in order for the election to be effective beginning with the year when made.


Both are flow-through entities, which means that income or losses flow to members or shareholders and they pay taxes on their individual income tax returns. Both have liability protection. An S corporation can have only one class of stock and the net income is allocated pro-rata based on stock ownership. An S corporation can have only individuals and certain trusts or estates and cannot have a foreign shareholder. An LLC has no such restrictions. The LLC operating agreement can provide for an allocation of most items of income and deduction in any manner in which the members see fit, subject to the allocation having substantial economic effect.


Professionals such as doctors, accountants, architects, lawyers, etc. are not allowed to take liability protection using the LLC form of business. They need to be a professional corporation that is much like a general corporation, except that while a shareholder is insulated from liability caused by acts of other shareholders, the shareholder is not insulated from liability because of his own acts. In addition, each shareholder is required to maintain liability insurance in specified minimum amounts.

Parveen Maheshwari, C.P.A., can be reached at (650) 340-1400 or

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