S Corporation Election

When comparing the limited liability company (LLC) and the corporation their tax implications are an important consideration, although tax considerations should be only one part of the overall decision process.

While operating as an LLC can be straightforward and uncomplicated, in contrast, operating as a subchapter S corporation can be more troublesome—although the "troublesome" aspects will very rarely affect a small business.

Only a corporation with 100 or fewer shareholders is eligible to be an S corporation. In addition, there can be one class of stock in the corporation. While this seems limiting, the fact that you can have voting and non-voting shares eliminates many of the issues for a family owned business. Although you can not have one type of stock receive a dividend while another does not, you can give non-voting shares to family members. Finally, any trust holding stock meets certain conditions--although these conditions will seldom limit what can be done in a small or mid-sized business.

Possibily the biggest impact occurs if you decide to change the form of business operation. Converting from an S corporation to any other entity is a liquidation that may trigger recognition of built-up appreciation in the corporation's value and trigger recapture of accelerated depreciation. Nearly all of these adverse consequences can be avoid with thoughtful tax planning by a professional.

In asset protection planning, when a holding entity and an operating entity are used, and the owner has chosen to form two corporations as opposed to two LLCs, the owner usually will have the holding corporation form and own the operating corporation, and then elect subchapter S status for both corporations.