“I wear the chain I forged in life,” replied the Ghost. “I made it link by link, and yard by yard; I girded it on of my own free will, and of my own free will I wore it.” ― Charles Dickens, A Christmas Carol
What is the tax benefit (if any) to forming a company as a limited liability company (LLC) rather than an S Corporation (S-Corp)?
As we said in our prior blog post, comparing the benefits of an LLC vs an S-Corp is a deep subject, usually requiring a semester or two of law school to master, but we intend to compress the analysis into a series of 5 blog posts. This week we turn to the abstruse question of the differing tax treatment for these two types of business entities.
The S-Corp is a corporation under state law. As a corporation, it is subject to various corporate and franchise taxes in the several states. However, the S election converts the corporation and its shareholders from being exposed to double taxation at the federal tax level by passing corporate income, losses, deductions and credits through the shareholders. Even so, as a corporation, an S-Corp is required to file a separate tax return on a Federal, state, and, sometimes, local level. The federal filing requirement is Form 1120S. Form 1120S is, for the most part, a flow-through information return and distributes a Form K-1 to the shareholders. Each state in turn has its own form for the return, and most of the states (including New York State) recognize the S election. However, New York City does not recognize the S election. The New York City S-Corp and the S-Corp that earns money in NYC must pay the NYC corporate tax of 8.85% with respect to any income that is earned in New York City.
The Limited Liability Company is a creature of contract and is taxed depending on the parties to the contract. A Limited Liability Company with only one member – a single member Limited Liability Company – is considered a “disregarded” entity, and has no separate filing requirements on the federal and state level. Instead, a single member Limited Liability Company is taxed on Schedule C of the Internal Revenue Service Form 1040. That treatment generally flows through the state. On a local level, New York City imposes an Unincorporated Business Tax on the single member Limited Liability Company. A special UBT return is required and a tax of 4% is applied. This tax is imposed after the first $95,000 of income.
A Limited Liability Company with more than one member is considered and taxed as a partnership, and has filing requirements different from those for the single member Limited Liability Company. On the Federal level, the Internal Revenue Service requires a Form 1065, which is a flow-through information return, and the LLC likewise distributes a Form K-1 to the members. The state generally follows this model, with some minimum tax requirements. On a local level, New York City imposes an Unincorporated Business Tax on the Limited Liability Company. A special UBT return is required and a tax of 4% is applied. The tax is imposed after the first $95,000 of income.
In general, the tax treatment for an S-Corp and LLC at the federal level is similar, although there will be a difference in the types of forms that need to be filed. There may be disparities in tax treatment at the state and local level, as is the case for LLC’s and S-Corps with a primary place of business in New York City. Setting aside these differences, the formation of either form of entity carries with it the same basic costs. However, in New York, Limited Liability Companies carry with them a publication requirement which we will discuss in our next post.