Corporation vs LLC- Which is Better?

By Stephen Nelson

"S Corporation or LLC?" is a common question for new business owners. I have several people call me each week asking this.

I always tell them the question is impossible to answer. And here's why. An LLC is chameleon for income tax purposes. Therefore, an LLC can be anything the owner or owners (who are called members) want the LLC to be-including an S corporation.

An LLC with one owner, for example, can be a sole proprietorship, a C corporation or an S Corporation. And an LLC with multiple owners can be a partnership, a C corporation or an S Corporation.

I think what people asking "LLC vs. S Corporation?" really want are the answers to two questions:

1. Which legal form should their new business or investment take?

2. What tax treatment should they select for their new business or investment?

Fortunately, these questions can be answered-and quite easily.

To answer the question about which legal form a new business or investment should take, I almost always give the same answer: You probably want to use the LLC because an LLC gives you all the same legal protection as a regular corporation only with half the calories--er, I mean, red tape.

The tax treatment question that people ask is a bit trickier. As noted earlier, an LLC can be just about anything. So making a smart tax treatment decision is tricky and something you'll want to consider carefully. Here are some of the issues to consider:

1. Investments and businesses that produce losses are often best operated as a sole proprietorship or partnership so that the losses pass through to the owner's or owners' tax returns and create tax deductions.

2. S corporations are often best if the LLC operates an active trade or business and self-employment taxes on the owner or owners are high. Note, however, that not every business is eligible to become an S Corporation.

3. If an LLC holds real estate or other passive investments, an S Corporation or C corporation is usually a very poor choice since the corporation may create an extra level of taxation.

4. If an LLC operates an active trade or business that does business in many states, a C corporation is often easiest for the owners because a C corporation probably reduces the multistate income tax accounting burden for the owners. Note that multistate tax accounting often becomes very cumbersome for shareholders of an S corporation.