S-Corps and LLC Statuses Explained

Which one of the two is beneficial? How do I file taxes if we are a multiple member LLC? 

An S corporation stands as a unique legal entity, initially organized as a corporation but making an election with the IRS for federal income tax purposes. Unlike regular corporations, an S corporation itself is not typically subject to tax. Instead, its income, losses, deductions, and credits flow directly through to its shareholders, resembling the structure of a partnership.

While it’s uncommon, there are situations where the S corporation may be accountable for taxes on specific built-in gains and passive investment income. Annually, the S corporation must file an income tax return using Form 1120S, the designated US tax return for S corporations. This report details the corporation’s income or losses, with each shareholder’s relevant share documented on Schedule K-1.

This unique setup allows shareholders to report the pass-through income or loss on their individual tax returns, effectively steering clear of the double federal taxation that traditional corporations face. To qualify for S corporation status, the entity must meet certain requirements: being a domestic corporation, having only eligible shareholders (partnerships, other S corporations, and non-resident aliens are excluded), maintaining no more than 100 shareholders, and having only one class of stock. It’s important to note that specific types of corporations, including certain financial institutions, insurance companies, and domestic international sales corporations, are ineligible for S corporation status.

Another category of business entities is the limited liability company (LLC), which can be established under state law, contingent upon whether it has a single owner or multiple owners. 

Depending on its structure, an LLC is classified for federal tax purposes in a few ways:

  1. It may be treated as a disregarded entity if it has a single owner.
  2. If owned entirely by a corporation or if the LLC elects corporate treatment, it can be treated as a corporation.
  3. Alternatively, it can be treated as a partnership for federal tax purposes.

Like owners of S corporations and partnerships, members of an LLC have the advantage of avoiding double taxation. 

An LLC offers the liability protection characteristic of a corporation while enjoying the tax benefits of a partnership. Unlike a partnership, individual members of an LLC are not personally responsible for the company’s debts.

In cases where an LLC is treated as a partnership for tax purposes, it is required to file Form 1065 annually, and one of its owners must sign the return.

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