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LLC vs. S-Corp

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    #1

    LLC vs. S-Corp

    Ok, just need a mental check here. I have two (50/50) individuals that came to me with a newly formed LLC. They are setup as a distributorship for certain medical equipment with exclusive distribution rights for one state right now and with others being added. They are basically the middleman between the medical community and independent commission only salespeople being paid via 1099. Basically, the company gets say 20% on the sale and 10% is passed down to the salesperson.

    For 2009, only minimal profit is expected. For 2010, the profits could get rather signficant (i.e. $300K). For now, my thought is to leave the LLC in place until such time as significant profit seems likely and then potentially make the S-Corp election for the purposes of saving on self employment taxes.

    Any thoughts? I know the LLC has more flexibility. However, any "traps" or "landmines" down the road by making the S-Corp election in 2010?
    "The hardest thing in the world to understand is the income tax" - Albert Einstein
    Tags: None
    #2
    Why wait?

    I would just go ahead and make the S election for this first year.
    Or is any purpose served by waiting till next jan 2nd?

    Hope you're drying out finally. I walked along our (Columbus, GA) riverwalk yesterday
    before they closed it due to all that water coming downstream.
    ChEAr$,
    Harlan Lunsford, EA n LA

    Comment

      #3
      How much

      How much of their profits will come from the personal services the two members provide? How much from the return on the capital they contributed? What do similar employees get paid for similar responsibilities and results in their industry? Will they need to hire someone (you?) to handle their payroll including commissions and filings? Are they likely to make distributions during the year NOT keeping to the 50%/50% without telling you? Are you doing their bookkeeping anyway? Or, will both members handle the bookkeeping? Or, just one? And, will they pay the two of them differently based on their different responsibilities. How have they been so far keeping the business separate from their personal finances? Keeping mileage logs and turning in expense accounts? Have they voted on an accountable plan? Is there much difference in the state fees for s-corps vs. partnerships/LLCs? We've all had clients that should NOT have additional complexity!

      Comment

        #4
        Originally posted by Lion View Post
        How much of their profits will come from the personal services the two members provide? How much from the return on the capital they contributed? What do similar employees get paid for similar responsibilities and results in their industry?
        Lion, if you weren't on the coast, I would swear you were just at the GearUp seminar I took yesterday in Minneapolis. I was going to ask the exact same questions. Those first few questions have made me question my clients that are S-corps (some that I suggested) should bump up the salaries.

        ATG
        "Congress has spoken to this issue through its audible silence."
        Anyone ever notice they beat the daylights out of the definition of a child, but they don't spend much time at all defining "parent"?

        Comment

          #5
          IRS Project

          The IRS seems to be examining S-corporations lately, and the state and federal labor departments are definitely looking into S-corporation salaries of shareholders for reasonableness based on their responsibilities and industry. I heard one IRS agent mention that he thought the US Dept of Labor agents saw a red flag if the salary was not at least double the distribution. CT is tougher than the US DOL. And, we know there's no safe harbor for shareholder salaries.

          Comment

            #6
            Originally posted by Lion View Post
            And, we know there's no safe harbor for shareholder salaries.
            There is one unofficial rule: declare it all. I've a feeling that's going to become law on all pass throughs in the next couple years. In a recent study by the IRS, 36,000 S-corps reported pass through income of over 100K and 0 officer's comp.

            ATG
            "Congress has spoken to this issue through its audible silence."
            Anyone ever notice they beat the daylights out of the definition of a child, but they don't spend much time at all defining "parent"?

            Comment

              #7
              36,000 S-corps reported pass through income of over 100K and 0 officer's comp.

              Just another example of a few bad actors ruining a good thing for the others.
              In other words, a democratic government is the only one in which those who vote for a tax can escape the obligation to pay it.
              Alexis de Tocqueville

              Comment

                #8
                Left Out Something

                You asked to expose "traps" and I just detected one.

                First of all, you have to be considered a corporation by the IRS before you can change to an S corp.

                If these two guys set up an LLC and "do nothing" they will by default be deemed to be a partnership and be required to file a Form 1065.

                In order to be a C-corp they must file form 8832, the "check the box" form and indicate they wish to be a corporation. Then they can change to an S corp next year if they so desire by filing Form 2553. If they want to be an S-corp from the beginning instead of a C-corp, they may file Form 2553 without having to file form 8832.

                So the "trap" is thinking they can wait a whole year before deciding to become a corporation. If they do this, they will be filing as a partnership by default.

                Comment

                  #9
                  Edsel, I understand the issue there. Just trying to simplify things by not having to incorporate payroll, etc. into 2009 for an S-Corp when the income is minimal. However for 2010, they are expecting income of $400K which they will split 50/50. I guess is there anything wrong with filing as a partnership by default this year? We would then file the 8832 and subsequently the 2553. Thanks again for the insight. Any other thoughts/considerations?
                  "The hardest thing in the world to understand is the income tax" - Albert Einstein

                  Comment

                    #10
                    Late Form 2553 election

                    Ok, one more issue. The LLC was formed in Feb.09. The company obviously missed the 2 1/2 month window to file the Form 2553. Accordingly, it could then get relief for a late election but wouldn't it start for the tax year 2010. Per the Form 2553 instructions - "A late election to be an S corporation generally is effective for the tax year following the tax year beginning on the date entered on line E of Form 2553". Thus, if 2/1/09 is on line E, would the S Corp start for the 2010 tax year?

                    How would you file 2009? Just as a regular LLC (Form 1065)? With the late election, it does not appear that Form 8832 would be necessary to indicate they wish to be a corporation.
                    "The hardest thing in the world to understand is the income tax" - Albert Einstein

                    Comment

                      #11
                      [QUOTE=Edsel;87254]If they want to be an S-corp from the beginning instead of a C-corp, they may file Form 2553 without having to file form 8832.QUOTE]

                      Considering the E&P issues that come with being a C prior to S, I'd just do the 2553. Also, the check the box is an irrevocable election for 5 years, so if the S status goes bad for some reason, they're stuck with C-Corp until that period ends.

                      ATG
                      "Congress has spoken to this issue through its audible silence."
                      Anyone ever notice they beat the daylights out of the definition of a child, but they don't spend much time at all defining "parent"?

                      Comment

                        #12
                        Originally posted by bbrownatl View Post
                        Ok, one more issue. The LLC was formed in Feb.09. The company obviously missed the 2 1/2 month window to file the Form 2553.
                        I'd try and file the 2553 for the beginning of the year. I had one where our "reasonable cause" was "we forgot, sorry", and they let it fly - and that was well into the second year of the S-Corp.

                        ATG
                        "Congress has spoken to this issue through its audible silence."
                        Anyone ever notice they beat the daylights out of the definition of a child, but they don't spend much time at all defining "parent"?

                        Comment

                          #13
                          Still a problem, I think...

                          Originally posted by bbrownatl View Post
                          I guess is there anything wrong with filing as a partnership by default this year? We would then file the 8832 ...
                          If you are assigned the default because you haven't filed the 8832, I don't think the 8832 is available to you again. I believe you have to get IRS permission to change, so you may be stuck with the 1065 unless you dissolve and re-incorporate.

                          Can't swear this is true, but for some reason the caution is stuck in the back of my head.

                          Bbrownatl, welcome to the message board!! There are some sharp minds who post here and if I am wrong, someone will probably drive the Edsel back into the '50s.

                          Comment

                            #14
                            Like a sch C cient, I believe a PS can do a 351 election to become a corp. Then, elect s status. No?
                            Dave, EA

                            Comment

                              #15
                              Not necessary

                              to jump thru the 8832 hoop. Merely file the 2553 under the late election procedures as
                              outlined by IRS. Sorry, don't have that notice number here at home. You can find it,
                              though, on the IRS web site.
                              ChEAr$,
                              Harlan Lunsford, EA n LA

                              Comment

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