Duvall & Associates, Inc.
BUSINESS ADVISOR NEWSLETTER
 

 LLC, Sub S designations each have their benefits

- by Alan Duvall 

Published in Dayton Daily News  May 13, 2007 

“I’m a changeling, see me change.”  -The Doors  

Sub S corporations - neither fish nor fowl.  Companies which offer corporate legal protection for owners but are intended to be taxed as partnerships. 

Corporations and Limited Liability Companies (LLC) can elect Sub S status to avoid taxes at the business level.  Most income and losses flow through directly to the owners to be taxed at individual rates regardless of whether the income is actually distributed. 

Thus, Sub S corporations avoid the double taxation of regular corporations (which are taxed at the business level and then again when dividends are paid).   

The Sub S system establishes a formula for calculating stock basis which should be calculated each year.  A shareholder’s stock basis is equal to the original stock price, plus/minus company income/losses, further reduced by distributions and increased by subsequent capital contributions or loans.  

The owner’s basis will reduce gain upon a sale of stock or company assets.  The basis will also determine the amount of tax-free distributions which can be made to the owner in the future.   

Company losses can only be deducted by owners to the extent of their respective basis in stock.  Should it become clear losses will exceed basis in a given year, an owner may contribute additional capital or even loan money to the company to assure adequate basis for current year loss deduction.  A mere owner guarantee of company loans is insufficient to increase basis – basis loans must be made directly by the owner to the firm.   

This limitation for deducting company losses is a major reason aspiring entrepreneurs should initially consider a LLC for their new companies.  In early years, LLC’s can elect to be taxed as partnerships which offer broader opportunities for owner deduction of start-up losses.  In later years when the company becomes profitable, the LLC can thereafter elect to be tax-treated as a Sub S company. 

At time of company sale, the single taxation of Sub S corporations can be especially appealing, as compared with double-taxed regular corporations which may cost owners as much as 30% of resulting gains in taxes. 

“Will I see you give more than I can take?  Will I only harvest some?”  -Neal Young 

Alan Duvall is a certified public accountant in Dayton.  Contact him at Alan@Duvallcpa.com.  Previous articles archived at www.duvallcpa.com.