"S" Corporation

This is a pass-through type entity. That means most of the income and deductions earned by the corporation is treated as if it were earned by the shareholders.The sale of business assets results in one level of taxation since generally the "S" corporation pays no tax. (There is an exception for "S" corporations that were converted from "C" Corporations.)

Sole Proprietorships Compared S Corporations

All of the business income of a sole proprietor reported on a Schedule C is subject to self employment tax. If an "S" Corporation pays a shareholder no wages, the amount retained is not subject to FICA taxes. Further, an "S" Corporation's contribution to a qualified retirement plan for the shareholder/employee is generally not subject to FICA taxes. A sole proprietor's contributions to a KEOGH or SEP Plan are subject to self employment tax. As long as the shareholder- employees of "S" Corporations set their salaries at a low, but reasonable, level, the balance could be considered a dividend payment, not subject to self-employment taxes.

Limited Liability Companies Compared to "S" Corporations.

1. Limitation of Liability. Both the LLC and the "S" Corporation provide similar limits on liability.

2. Pass-Through Entities. Even though an "S" Corporation and an LLC treated as a partnership are both "pass-through entities", there are many restrictions that apply to an "S" Corporation that do not apply to LLCs. These "S" Corporation restrictions include a limitation of 75 shareholders, the fact that shareholders can only be individuals, estates, and some trusts, and there can only be one class of stock. This greatly limits the "S" Corporation as an entity for transferring interest between generations. Other restrictions include prohibitions agreement. Corporation electing "S" status if it is not a domestic corporation.

3. Limitation on "S" Corporation Deductions. "S" Corporation shareholders can deduct losses only to the extent of their basis in stock plus the amount of any debt for shareholder loans made to the "S" Corporation. (See IRC Section 1366). Even if the "S" Corporation Shareholder personally guarantees the corporation's debt, as is the typical creditor's requirement for most newly formed "S" Corporations, losses cannot be deducted on that debt. In contrast, LLC members are treated as partners for tax purposes and obtain additional basis in their LLC membership interest for their allocated share of LLC debts. This could result in increased deductions for LLC members compared to "S" Corporation members.

4. Foreign Members. The LLC may have different tax treatment for foreign members than a partnership/corporation in their home country. Also, foreign business associates may not be familiar with the Limited Liability Company as a business entity