LLC or Corporation
LLC or Corporation
What is the right entity choice for your business?
|Businesses operated or invested in by non US residents;|
|Real estate ventures with anticipated revenues less than $250,000; or|
|Businesses with other entities (corporations, LLCs, trusts, estates) as investors.|
The majority of small businesses operate as S corporations. An S corporation is a regular corporation that has made a special election with the IRS in order to avoid the double taxation associated with regular C corporations.
What is an “S” Corporation
An “S” corporation is a corporation that has made an election with the IRS to be treated for tax purposes as a “pass-through entity.” This means that corporate profits and losses are passed through to the shareholders (owners) who report them on their own personal tax returns and pay the tax at the individual level. The corporation pays no federal income tax at the corporate level. The “S” in S corporation refers to the subsection of the IRS code under which the corporation is taxed.
What is “double taxation”?
A corporation is a taxpayer in its own right, separate and distinct from its shareholders, and is taxed at the corporate tax rate. The individual shareholders are also taxed on dividends received from the corporation with no corresponding deduction to the corporation. This results in double taxation (the same money is taxed twice). This double taxation may be minimized by the payment of salaries to shareholders and by the use of shareholder loans. However, corporations issuing excessive or unreasonable salaries to their shareholders often face penalties from the IRS.
What is a “C” corporation?
All corporations formed by default are “C” corporations. A C corporation is a corporation that has not made an election to be an “S” corporation. The term C corporation is specifically used because the entity is taxed under subsection C of the IRS code. C corporations are taxed at two levels (“double taxation”). This means that the corporation itself pays its own tax when it makes money (the first tax). The owners or shareholders are then taxed again when they are paid a salary or dividend by the corporation (the second tax). Despite double taxation, C corporations offer many planning and benefit opportunities. For example, a C corporation can be used to accumulate assets or wealth at corporate tax rates, which are lower than the individual tax rates.
What is “Self-Employment Tax”?
Self-employment (SE) tax is a 15.3% tax on income. This rate, 15.3%, is a total of 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).
Normally these taxes are withheld by your employer. However, if you are self employed, it is your responsibility to pay them yourself.
The SE tax rate for business owners is 15.3% tax of the first $90,000 of income and 2.9% of everything over $90,000.
S corporations have a significant advantage when it comes to the payment of SE taxes. In an S corporation, only the salary paid to the employee-owner is subject to employment tax. The remaining income that is paid as a distribution is not subject to SE tax under IRS rules.
Owners of LLCs, partnerships and sole proprietorships, however, pay SE tax on their respective share of profits rather than salary.
Certain types of LLC income, however, are not subject to self-employment tax. For example, rentals from real estate and capital gains are not considered to be self-employment income, so real estate LLCs often need not be concerned with self-employment tax.
If I am a non-resident alien, can I form an LLC?
Yes. A non-resident alien (a person who is not a citizen or national of the United States and who is in this country on a visa or temporary basis and does not have the right to remain indefinitely) can be an owner of a LLC. An S-corporation cannot have a non-resident as a shareholder.
Gross Receipts Tax
In addition to the minimum franchise tax, some California LLCs taxed as partnerships must pay an annual entity level tax based on the “total income” which is worldwide gross income, plus the cost of goods sold, paid or incurred in connection with the LLCs business. This “gross-receipts tax” only applies to LLCs grossing over $250,000 a year. The tax ranges from $900 to $11,790, as follows:
|Total income||Annual Fee|
|Less than $250,000||0|
|$250,000 to less than $500,000||$900|
|$500,000 to less than $1 million||$2500|
|$1 million to less than $5 million||$6000|
|$5 million or more||$11,790|
An LLC taxed as partnership for federal tax purposes must pay an annual fee based on total gross revenue pursuant to California Revenue and Taxation Code Section 17942. This “gross receipts tax” can range from $900 for annual gross receipts less than $500,000 to as much as $11,790 for annual gross receipts greater than $5 million per year. The gross receipts tax does not apply to an LLC taxed as a corporation.