The most popular form of business entity today in the United States is the Limited Liability Company (LLC). While LLCs and S-Corporations share many of the same characteristics, such as limited liability and pass-through taxation, there are several important differences that make the LLC a very popular choice of business entity.
First, LLCs do not have the shareholder limitations that S-Corporations face. States do not enforce any limitations on the number of members an LLC can have. (Owners of an LLC are called members, not partners.)
Second, S-Corporations must allocate profits and losses pro-rata. For example, an S-Corporation with two shareholders and income of $100 for the most recent calendar year must divide the $100 equally, $50-$50, between the two shareholders.
LLCs (and all other forms of partnerships) can take that $100 of income and allocate $80 to one member and $20 to the other member, for example. This same type special allocation can be done with expenses, as well. The flexibility to allocate economic transactions is a significant advantage of forming a business as an LLC. (There are guidelines for making special allocations that will be discussed in an upcoming article.)
The flexibility to make special allocations of income and expenses, however, comes with a downside – compliance requirements can become very significant, both in terms of time and money. Many attorneys and CPAs agree that the most complex component of the U.S. tax code is the section that governs partnerships (Subchapter K).
But don’t let these potential compliance requirements scare you from organizing as an LLC. Many smaller partnerships don’t consistently encounter these more complicated tax scenarios.
If your LLC does end up encountering these more complicated tax situations, chances are the business has grown to the point that the financial resources will be available to properly meet your compliance obligations.
But what if your business isn’t a partnership? What if you’re the only owner? Can you still form your business as an LLC? To answer these questions, let’s dive in to the last type of entity we’ll be discussing, the sole proprietorship.