What's Optimal: Subchapter S corporation or LLC?

People considering limited liability company formation often ask the "llc versus Subchapter S corporation" question.

Unfortunately, this question is impossible to answer because it's moot. But let me explain.

First of all, the real choice is between an LLC or a regular, old-style corporation. And the answer, at least for small businesses, is clear: Because an LLC requires less red tape than a regular, old-style corporation yet gives its owners the same legal protection, you want to be an LLC. Period.

Second, as noted elsewhere at this web site, an LLC can be treated as an S corporation for tax purposes (assuming the entity meets the traditional S corporation requirements.) So, you're not choosing between an LLC and an S corporation but rather choosing whether or not to have your LLC treated as an S corporation for tax purposes.

Making a smart subchapter S corporation election can be tricky--so you may want some professional help. But here are some of the issues to you'll want to consider:

• Investments and businesses that generate tax losses are often best operated as a partnership or sole proprietorship so that the operating losses flow through to the owner's or owners' tax returns and produce tax savings.
• S corporations are often best if the LLC operates an active business and pays high self-employment taxes. Unfortunately, however, not all businesses are eligible to elect S corporation status.
• You can sometimes combine entities and get the best of both worlds. For example, you can create a partnership of S corporations in certain circumstances.
• Generally, you want an active trade or business LLC treated as a sole proprietorship or partnership in the early years of the business, when there are losses or modest profits. When the business later becomes more profitable, you want the active trade or business LLC treated as a C corporation or S corporation. (An LLC makes this sort of metamorphosis very easy.)
• When a limited liability company owns 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.
• 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 the business can often reduce the multi-state income tax accounting burden by choosing C corporation taxation after forming an LLC.