The S corp versus LLC argument never ends. CPAs, lawyers and small business people continue to discuss the question. However, Washington state business owners and entrepreneurs have three special reasons for choosing an LLC.
Quick Background Information on the S Corp vs. LLC Question
Before getting into the reasons why you want to use an LLC rather than an S corporation in Washington state, you want to understand a bit about the S corporation election. Let me explain one or two things up front, therefore.
Both LLCs and corporations may make the Subchapter S election. Accordingly, you can create an S corporation by setting up a corporation and electing S status. And you can create an S corporation by setting up an LLC and electing S status.
Furthermore, if you set up an LLC and don’t elect S status, how the LLC handles its tax accounting depends on the number of LLC owners. A one owner LLC does its accounting the same way that a sole proprietorship does. A multiple owner LLC does its accounting the same way that a partnership does.
One unique feature of sole proprietorships and partnerships is that the business entity doesn’t pay taxes on the business profits. Instead, the owner reports his or her share of the profits on his or her individual tax return and then pays the income taxes on the profits there.
The dual routes to S corporation status mean is that when people talk about S corp vs LLC, they really, it turns out, are asking whether the “corporation” S corporation is better than an LLC that hasn’t made an election. With this background understanding, you can quickly understand the case for choosing a limited liability company in Washington State instead of a corporation treated as an S corporation.
Reason #1 to Choose LLC: No State Payroll Taxes on LLC Members
Like most states, Washington State charges state unemployment taxes on payroll. Washington State also charges workers compensation insurance premiums on wages. The actual state payroll tax rate a business pays varies depending on their industry and employment history, but the tax often runs between 2% and 4% on employees.
Here’s the weird thing about these state payroll taxes, though. A “corporation” S corporation pays the state payroll taxes on the wages of an owner working in a “corporation” S corporation, but neither an LLC nor an “LLC” S corporation do.
While a “corporation” S corporation may opt out of covering shareholder-employees after the first year of operation, a corporation (including a “corporation” S corporation) pays higher state payroll taxes than an LLC in Washington State at least in the beginning. And that means that an LLC saves a small business state payroll taxes.
Reason #2 to Choose LLC: Charging Orders
Charging orders represent a second reason to use an LLC rather than a corporation for a small business in Washington State.
Without getting into too much detail, if you’re a Washington state business owner or entrepreneur, you should know that probably you can’t be personally sued and then through court action lose your interest in an LLC. However, you can be personally sued and then through court action lose your shares in a corporation.
Say you cause an automobile accident some weekend where someone is terribly injured, that you get sued for more than your insurance will cover, and that in the end a judge tells you to pay a million dollars to the injured person. In this worst case scenario, the injured person may be able to gain ownership of shares of stock in your small business corporation. But the injured person probably won’t be able to gain ownership of your interest in a limited liability company.
In Washington State, like a number of other western states, the injured party will only be able to get a charging order which will say that if the LLC is going to distribute money to you, the owner, that money should instead go to the injured party.
This charging order business is a technical legal point, obviously. But the charging order regimen means that in Washington, as in a handful of other states, an LLC is safer to own than a corporation. You’re simply less likely in Washington to lose your ownership interest in a small business when you’ve used an LLC.
Reason #3 to Choose LLC: Possible to Phase S Election
One other reason exists to choose an LLC over a corporation: The possibility to do a phased set up. But let me explain.
If you set up a corporation, from day one of your business, you will have the responsibility to file a corporation tax return and do payroll for shareholder-employees. This tax accounting stuff is expensive and complicated. You’ll end up paying at least several hundred dollars and very possibly several thousand dollars in extra accountant fees and extra payroll-related taxes each year.
If you set up an LLC, however, you can wait a bit to elect S corporation status. Say you set up an LLC mid-year, for example. In this situation, you can wait until the business gets established (perhaps a year or two?) before making the S election. That’ll delay the cost and complexity of corporation tax returns and shareholder payroll. Why? In the months or years before you run the business as an S corporation, the LLC will get treated as a sole proprietorship if it’s a one owner business or as a partnership if it’s a multiple owner business.
In short, the phased delay in electing S corporation status will save you money in those first months or years of your business’s operation. And that’ll be a good thing.
Note: An LLC in most or at least many other states can save taxes and accounting by “phasing” their S election. This advantage, therefore, isn’t unique to Washington State.
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