Inconceivable! S-Corps vs LLCs

Inconceivable! You keep using the word ‘S-Corp,'  but I do not think that word means what you think it means. Fans of The Princess Bride will recognize the reference, but in this video, I’ll talk about S-Corps (S-Corporations): why you might be using that term incorrectly, what they are, and how they can help you save money. I’m Scott Rattigan, founder of Functional Lawyer. You’ll find us at OriginsIncubator.com as well. We help functional medicine doctors establish their business and legal foundations, solid and secure, so that they can focus on helping their patients in their states. 

Sometimes when I have a legal-health assessment with a provider (some of you who don’t know me can set up a consultation with me at FunctionalLawyer.com), one of the questions in the questionnaire is, “What kind of entity do you have if you have one?”  Often, I hear people say that they have a S-Corp. When I ask them, “Okay, well, does that mean you have a corporation with S-Corp status, or do you have a LLC with S-Corp status,” they look at me as if I have three heads. So, let’s talk about what S-Corp actually means, what it is, and then how it might be able to save you some money.

Types of Entities

Entity types are Partnerships, Sole Proprietorships, Limited Liability Partnerships, Limited Liability Companies, Corporations, Professional Associations, and Professional Corporations. There are others as well.  A S-Corp is not a type of entity. 

C-Corporations vs. S-Corporations

Traditional corporations are known as C-Corporations to clarify that they are not a S-Corporation. S-Corp is somewhat of a misnomer. A S-Corp is a variation of a corporation within subchapter S of Chapter 1 of the Internal Revenue Code. These classifications were needed to distinguish between how the two operate. 

C-Corporations

C-Corporations, like Apple, Inc., typically have what is called double-taxation, so when the company makes money and has a profit at the end of the year, in their earnings column you might have reference to that.  They pay corporate tax straight up. (That is where you often hear in the headlines the corporate tax grid is too high or too low.) So, the corporation pays taxes on their profit having made a $100 million. Let’s say they gave 10% in an ideal world on that, so now they have $90 million left. When they take that $90 million and they distribute some of that to their shareholders, their shareholders also pay tax on that $90 million. So, the shareholders will pay either capital gains tax or full income tax at their marginal tax rate of 2.39%, or whatever the highest rate is today. So that $100 million gets taxed once at the corporate level and once at the shareholder level. That’s what is called double taxation.  

S-Corporations

S-Corporation classification, Subchapter S or Chapter 1 of the Internal Revenue Code where it gets its name from, allows the company to pass through and divide its profit and or losses on market dollars. So, let’s go back to my previous example with an eligible company that has made $100 million profit (Apple would be ineligible) and is a S-Corp. This S-Corp has $100 million in profit. Instead of paying a corporate tax rate, they pay nothing at the corporate level, and then when they distribute $100 million to their shareholders, say there are 10 of them, each shareholder pays income tax or capital gains tax on $10 million each. If they had the double taxation in this instance, each of the 10 shareholders would’ve paid income tax on $9 million, though you can see there’s an additional $1 million to each person. I know most of you don’t have $100 million in profit each year, but the numbers do add up and can make a big difference in the long run. 

Why are we talking about this? Lots of people have either a limited liability company (LLC) or they start a personal corporation (PC) for their medical practice. You’ve heard the term S-Corp in the past, and it is beneficial in most cases. Now here’s the part where I say, “Stop and consult with your accountant and any tax professionals you might be working with, and determine if this is right for you.” But let’s talk about some of the benefits and some of the cons to having an S-Corp as well. 

S-Corp Benefits

One of the benefits is that you avoid double taxation. Another benefit is that you are eligible to open up different kinds of investment vehicles, such as a SEP IRA (a self-employed person IRA), and you can put more money into an IRA account for retirement.  (There are some pros and cons to that in a separate video.) So, these are some of the benefits, the main one being pass-through taxation. Yet, not everybody is eligible.

Who’s Eligible for S-Corp?

Both LLCs and corporations are eligible. And we’ll stick with these because these are the most common entity types there are. 

To be eligible, under the IRS rule to qualify for S-corporation status, the following requirements must be met: 

• It has to be a domestic corporation, meaning U.S. states, it has to have only allowable shareholders, which means it has to be individuals, U.S. citizens (permanent residents only), certain trusts and estates, and the owners may not be partnerships, corporations, or non-resident alien shareholders; 
• It has to have no more than 100 shareholders, which is why Apple would not clearly be eligible earlier;
• It has to only have one class of stock (most big corporations are not eligible for that because some may have voting rights that others don’t, and some may have other distribution rights that others don’t, depending on the corporate structure of that entity);
• And some institutions are just not eligible as a matter of rule, so financial institutions, insurance companies, and domestic and international sales corporations may be ineligible for S-corporation.  

The one reason you would elect S-Corp, as we discussed, is to avoid double taxation. Keeping more money that you make for yourself is a good thing, but we should all pay our fair share of taxes; however, if you can legally set up a way to do it where you pay less and keep part of your hard earned income, then that’s certainly an avenue to explore. 

S-Corp Cons

Some of the cons include not everyone is eligible. Also, in some instances, not all, it can actually lead to increased taxes for you. 

But for the vast majority of you, a S-Corporation is going to be a tax-saving vehicle, so consult with your CPA, your tax professional, or tax lawyer in order to set up your entity. 

S-Corp Election

The rules say you have 75 days from starting your entity in order to elect S-Corporation status. You do that by going to IRS.gov website, search for S-Corp, and fill out a form that says you want to be a S-Corp. If you have not elected for it in the first 75 days, that is okay because you can still make a late election. After the first 75 days, it will be a little more of an administrative burden on you, and you will have to work closely with a tax professional in doing that as well.  

Conclusion

So, that is what S-Corps are. Remember you don’t have a S-Corp. You have a C-Corporation that has elected a S-Corp tax classification, or you have a LLC that has elected to be taxed as a S-Corp. 

Keep using those properly, and if you have any questions about any of that or want more on how to correctly set up your medical practice, you can set up a consultation with me, Scott Rattigan, at FunctionalLawyer.com.