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LLC, C-Corp, S-Corp?
Hello everyone,
My little studio has been a partnership for too long now, and we are in the process of considering our business format options. There isn’t a lot of information available regarding which format studios typically go with, so I figured I’d pose the question here.
My understanding overall is that LLCs and S-Corps have the same pass-through taxation as a sole prop/partnership, whereas the tax structure of a C-Corp provides a way to pay the lower, corporate tax (15%) on retained profit rather than paying your personal tax rate on every penny of income.
I realize there’s more to the issue than just taxes, so I was hoping people here could sound off. What’s YOUR business structure, and why?
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18 Replies
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Hi Brendan…
Our little company is, and has been since its inception 11 years ago, an S-Corporation. Now, exactly why we chose to incorporate as an S-Corp, I can’t say… that was just the advice of our lawyers and our CPA at the time.
I will say that an S-Corp does have some difficulties, and we have considered converting to a C-Corp on occasion (and should probably revisit that). The biggest challenge, is of course taxes and profits. As you said, the S-Corp pays no income taxes, but the tax burden falls upon the owners (in my case, I have 80% of the tax burden and my general manager who is also a stockholder has 20% of the burden).
What we find is that at the end of the year we are spending money like crazy, buying everything we can, paying bonuses, whatever… anything we can do to get rid of “profit” at the end of the year so we don’t have a big tax liability. That’s all well and good, but it also makes January (and sometimes February) very lean and cash poor… especially since we sometimes delay invoicing December jobs until January to keep the profit off the books… which delays that money coming in even more.
Just some thoughts….
T2
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Todd Terry
Creative Director
Fantastic Plastic Entertainment, Inc.
fantasticplastic.com
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As Todd mentions, an S-Corp does not have all of the options that a C-Corp does. A C-Corp creates an entirely new entity that is entirely separate from you, the individual.
The downside of having two entirely separate entities is having to prepare and file two (actually four when considering state returns) separate tax returns, meaning that the maintainance cost may be somewhat higher. However, that downside can also have an upside, because you have the option to get paid through the entity that benefits you the most.
Rather than taking our word for it, I would advise consulting your tax advisor or CPA.
David Roth Weiss
Director/Editor
David Weiss Productions, Inc.
Los AngelesPOST-PRODUCTION WITHOUT THE USUAL INSANITY ™
A forum host of Creative COW’s Business & Marketing, and Indie Film & Documentary forums.
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LLC. Our Tax Advisor recommended it as the easiest set up and most tax beneficial to our company.
Walter Biscardi, Jr.
Biscardi Creative Media
HD and SD Production for Broadcast and Independent Productions.STOP STARING AND START GRADING WITH APPLE COLOR Apple Color Training DVD available now!
Read my Blog!
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Todd,
This is actually one of the primary reasons we are feeling the need to switch structures – those end of year spending sprees, because you either do that or send the money to Uncle Sam.
Brendan Coots
Splitvision Digital
http://www.splitvisiondigital.com -
Hi Brendan,
My one-man shop is set up as an LLC with S-Corp classification. My accountant says that having a S-Corp classification allows me to take my dividends payments without having to pay soo much Social Security on them. My regular salary payments get taxed as usual.
Bruce
Bruce Bennett
Bennett Marketing & Media Production, LLC -
I’m also set-up as an S-Corp, for 20 years now. Not sure the LLC option was even available in 1988 and really not sure what it means for Bruce to be both an LLC and an S-Corp. I like others here, took the advice of my accountant and attorney, assuming that they knew their jobs at least as well as I knew mine.
And umm, hey guys, at the end of the year there are worse things than taking a chunk of cash and paying the tax on it. It does however make sense to also use a bank line of credit to smooth out those lean months. IMHO.
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[Brendan Coots] “My understanding overall is that LLCs and S-Corps have the same pass-through taxation as a sole prop/partnership, whereas the tax structure of a C-Corp provides a way to pay the lower, corporate tax (15%) on retained profit rather than paying your personal tax rate on every penny of income. “
I’ll try to discuss the differences (in general) in the taxation of the different business structures. I see from your profile that you’re in San Francisco (like myself), so I’ll address some of the state issues as well. Of course, there may be legal reasons for choosing an entity type that may not be the most advantageous for tax purposes. With regard to the legal matters, I am not qualified to address those. Please note that this post is not to be considered as tax advice.
C Corporation – I think you might be confusing the first tier of the C Corp’s corporate tax rate with the qualified dividend rate of 15% that an individual taxpayer pays on dividend income. A C corp pays 15% tax on its taxable income up to the first $50,000. For taxable income of $50,001 – $75,000, it’s 25% (in addition to the 15% on the first $50,000), from $75,001 – $100,000, the tax rate is 34%, and from $100,001 – $335,000, it’s 39%. Once you get over $335,000, the tax rate starts to fall again, but it never gets below 34%. California will tax you at a flat rate of 8.84% (but not less than $800).
One of the biggest drawbacks to the C corporation structure is double taxation of income. Not only are the net profits taxed at the corporate level, but when you as the owner want to take money out of the corporation, those payments are considered dividends, and you pay tax on those dividend payments. As an example (ignoring state taxes), the C corp has taxable income of $25,000. It pays corporate level of tax of $3,750, leaving $21,250 available to retain or pay out as dividends. Assuming it pays the entire amount out as dividends, the owners would get hit with a 15% tax on the $21,250, which is $3,188. So, between the corporation and the owner, they pay total taxes of $6,938 on the $25,000 of income. That’s an effective rate of just under 28%. That effective rate goes up as the corporate tax rate increases.
You’ve also got corporate formalities to deal with (board meetings, keep minutes, etc.), which is more trouble than some small companies want to get into.
S Corporation – S corporation income flows through to you, the owner, and is taxed on your personal tax return. The S corp (except in very specific circumstances) does not pay any federal taxes, but will pay CA taxes at 1.5% (but not less than $800) on its net income.
S corporation income is not considered to be self-employment income, so the income that passes through to you is not subject to social security and medicare taxes. This is one big reason why many people like to use S corps, and this is what Mr. Bennett is doing. However, you can’t pay yourself a minimal salary to let most of the income pass through to you and avoid the SE tax. You still have to pay yourself a reasonable salary – reasonable being what other people in the same industry in your position would be paying themselves.
You also still have some of the same requirements with regard to the corporate formalities with an S corp.
LLC – An LLC is easy to administer, as you don’t have the same formalities to go through as you do with either of the corporate entity types.
Like an S Corp, the LLC income passes through to the owners, where they pay the tax on their personal returns. The LLC will not pay federal taxes, but CA institutes a gross receipts fee that’s not based on your net income, but your receipts. There’s no fee if your receipts are less than $250,000, and then the fee progresses to $900, $2,500, $6,000, and finally $11,790 for gross receipts in excess of $5,000,000. As you can see, this means that you’d still be subject to the $11,790 fee if your receipts exceed $5,000,000 but you had a net loss for the year. As a fee and not a tax, it’s deductible on the CA return for the year in which it’s paid.
LLC ordinary business income will be subject to SE tax on the owner’s personal tax return.
Partnership – From your post, it sounds like this is what you’re operating as at the moment. Income passes through to the owners’ personal tax returns, and the ordinary business income is subject to SE tax. There are no taxes at the entity level for federal purposes, and CA only charges the $800 franchise tax, unless you’re operating as a general partnership – then you aren’t subject to the $800. However, I seriously doubt you’re operating as a general partnership since that would mean that all the owners have unlimited liability. I assume you’re a limited partnership, but even then, there has to be at least one general partner who has unlimited liability.
All of the above entities (as well as a sole proprietorship) can take advantage of the IRC Section 179 expense deduction, allowing you to write off purchases of certain property in the year of purchase, rather than having to depreciate that property over 3, 5, 7, etc. years, which is what Mr. Terry is referring to. In 2007, the maximum Sec. 179 deduction was $125,000. If you purchase too much equipment during the year ($500,000 in 2007), the amount of Section 179 deduction you can use begins to get reduced. California, on the other hand, only allows a Section 179 deduction of $25,000. This deduction passes through to the owners of the passthrough entities on the Schedules K-1.
No matter the type of the entity you choose, you still have to file tax returns for those entities in addition to your own personal return. The exceptions are the sole proprietorship and the single-member LLC, both of which are reported on your 1040, Schedule C. In CA, you’d still have to complete the state LLC return to figure out the gross receipts fee I mentioned earlier. And, since you are already operating as a partnership, neither of those exceptions to filing separate returns is available to you.
The spending sprees at the end of the year are well and good assuming you need the equipment either at that time or in the near future. The ability to immediately expense some or all of that purchase for tax purposes should be a secondary consideration. It certainly doesn’t make sense to spend the money just to save on taxes – since you’d be spending $100 to save $35 or so.
Hope this helps.
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Steve certainly gets the award for most informed and best tax related post in the history of the Cow. Well done!!!
What I want to know is, how is it possible for a CPA to have any part of his brain left over for video related technical issues??? I can assure you, after dealing with the technical issues, I have no part of my brain left over for tax related matters.
David Roth Weiss
Director/Editor
David Weiss Productions, Inc.
Los AngelesPOST-PRODUCTION WITHOUT THE USUAL INSANITY ™
A forum host of Creative COW’s Business & Marketing, and Indie Film & Documentary forums.
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Wow, excellent reply – I appreciate it VERY much! This is a better description of the options than I found even on Nolo’s site.
Brendan Coots
Splitvision Digital
http://www.splitvisiondigital.com -
One more thing about the S-Corp vs an LLC, at least here in Wisconsin. I do a lot of work with corporate clients. As an S-Corp, after they pay me for my services there is no more paperwork necessary. With an LLC, in Wisconsin, the corporate client must issue a 1099 at the end of the year.
Not a deal breaker, by a long shot, but if most of your work is B2B, being an S-corp can be a somewhat advantage to your clients.
I personally like the S-Corp payroll plus distribution model, at least at this stage of the company. Sounds like Fantastic Plastic is raking in the dough…what a problem!
Why not simply pay yourself and buy some real estate? That will shelter it pretty well. Sure you can have the company buy equipment, but why not pay yourself and buy some property?
2¢
Rich Rubasch
Tilt Media
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