In the last blog on S-corporations and Limited Liability Companies, we introduced S-corporations and reviewed the overall similarity in how S-corps and LLC’s are taxed. In this blog, we will discuss some of the crucial differences between these business entities.
One of the most important distinctions between an S-corp and an LLC involves ownership. In general, an S-corporation may have only shareholders who are: (1) individuals who are U.S. citizens; (2) resident aliens; (3) certain types of trusts; and (4) other S-corporations.
Crucially, a corporation can lose its S-election if it acquires a shareholder who does not fall within one of these categories. For example, if a shareholder who is a US citizen sells or gives his or her shares to the limited liability company, the corporation will automatically lose its S election status. This can have very negative tax consequences, as it automatically subjects the corporation to the high tax rates that apply to C-corporations.
If your company will have any owners who are not within one of the categories described above, and you want to be taxed on a pass-through basis, you will need to choose an LLC. For example, if one of your investors is a foreign national, or wants to hold his interest through an LLC holding company, an S-corporation is out of the question.
However, there may also be situations where an S-corporation is out of the question. In California, an LLC is not available to most businesses that must have a professional license. For example, an attorney, physician, accountant, or engineer may not use an LLC. This leaves the S-corporation as the only alternative for California professionals seeking the protection of a corporate entity and pass-through taxation.
This is just a basic overview and is not legal advice specific to your situation. If you would like to speak with Jonathan about your situation, please email him at firstname.lastname@example.org or call him at 925-217-3255.