The ABCs of LLCs and Corporations
Tips to Selecting the Right Legal Structure
January 19, 2012
Certified financial planner Stan Mead has owned his business, Novations, for six years. He originally operated under an LLC partnership. After consulting with MainStreet Tax and Accounting Services in Salt Lake City, he received a greater understanding of corporate entities and determined that he needed to create a holding company that is an S-elected LLC.
“I now have two entities operating one underneath the other. The holding company retains my business assets, and the operating company underneath is the one that everyone interfaces with. It maintains the liability,” he explains. “It’s been very efficient to operate my business that way because I pass revenue from the operating company up to the holding company and pay myself a salary. I created a personal 401(k) which is held in the holding company.”
Mead also learned how he can distribute assets out of the operating company into the holding company. He can then distribute some of those assets, as needed, to himself and any other holding company owners.
“I had an employee for the past two years. Paying the employee through the operating company was very effective,” he says.
Determining the Right Structure
Entrepreneurs such as Mead should legally organize their businesses by choosing the entity structure that will provide them with the best asset protection while allowing the most advantageous tax strategies.
David B. Larsen, managing partner at MainStreet Tax and Accounting Services, advises entrepreneurs to meet with an accounting professional to discuss their business plan.
“Because S-Corps, C-Corps, LLCs and S-elected LLCs provide the same asset protection, provided owners are compliant with all necessary requirements. The only reason for choosing one entity over another is in regards to future business plans,” says Larsen.
Entrepreneurs beginning a small business with little expectation for massive growth should create a S-elected LLC or a S-Corp for tax purposes.
“Although every situation is different, we recommend S-elected LLCs for more than 90 percent of our Utah small business clients,” he says. “While S-elected LLCs are not new, many business owners believe that they have to choose between the tax incentives of a S-Corp and the ease of an LLC. The S-elected LLC allows for the best of both.”
Consider these Differences:
The S-elected LLC
The S-elected LLC offers the ease of operation of an LLC with the tax incentives of a S-Corp, including the option for owners to choose a reasonable salary to be taxed and for members to freely distribute money from the company capital without incurring self-employment tax. No corporate regulations or records are required and members can be individuals or entities.
“The S-elected LLC has been very easy to use, and I now have good ideas about how to protect assets and maximize the value of my corporate entity,” says Mead.
The S-Corp is a pass-through entity, where the owners can also choose a reasonable salary to be taxed and no self-employment tax is required to be paid on net income. The S-Corp, however, involves more compliance. Larsen explains that legal protection can be jeopardized if the organization is not compliant with corporate regulations which specify that annual shareholder and board of directors meetings and an election of officers, must be held, all requiring recorded minutes. The corporation is further required to maintain corporate resolutions for financial transactions, including the creating of bank accounts, opening credit cards or any fiduciary transaction.
A Professional Limited Liability company functions as a regular LLC in all areas, except that all owners (members) of the LLC must be licensed professionals in their field, Larsen explains. This distinction benefits the company by showing clients that the owners are licensed experts in their particular industry. A drawback to such an organization is that the company can be difficult to sell or buy, since the new owners must also be licensed.
“For example, we have one client who is a licensed dentist and runs his practice as a PLLC,” Larsen says. “His son and son-in-law both work in the dentistry field as technicians, but are not licensed dentists. When it comes time for our client to retire, he cannot sell his company to his son or son-in-law since they are not licensed dentists unless he restructures his company as a regular LLC. At that point, the boys could purchase the business and hire a licensed dentist to work for them. Even if the office was full of licensed dentists, unless the owners of the LLC are licensed themselves, it cannot be organized as a PLLC.”