Asset Protection – S-Corporations, LLC and Tax Planning

Both LLCs and S-Corporations are tax-reporting net income tax-paying entities. LLCs/S-Corporations pay a $800 minimum California tax, S-Corporations pay a 1.5% California corporate level tax, LLCs pay an annual “gross receipts tax”, based on gross income:

Income / Tax

$0-$250,000 / $0

$250,000-$499,000 / $900

$500,000-$999,000 / $2,500

$1m – $4.99m / $6,000

$5m+ / $11,790

S-Corporations

1. May not issue preferred shares. Voting and non-voting common stock may be issued, but in all other respects, S-Corporation’s shares must be identical in their rights and privileges.

2. Neither a corporation nor a non-resident alien can be an S-Corporation shareholder.

3. The inside basis of appreciated assets held by the S-Corporation (fair market value in excess of adjusted tax basis) may be adjusted to FMV upon the deceased owner’s death for the successor’s benefit.

4. Owners of the shares of an S-Corporation obtain no owner level basis adjustments for entry level debt (S-Corporation debt is not allocated as an upward basis adjustment among shareholders), thereby limiting the ability of S-Corporation shareholders to claim entity level losses passed through to them.

5. Distributions in kind of appreciated property from an S-Corporation to its shareholders is subject to a “deemed” sale treatment with gain recognition and taxation.

6. Contributions of appreciated property to an S-Corporation will result in recognition of gain to a shareholder.

7. A U.S. based S-Corporation, with outbound investment objectives may not establish and hold an 80% or more owned subsidiary to conduct operations abroad.

Limited Liability Companies

1. Various classes of interests in a LLC may be created without risk to the income tax classification of the LLC as a pass-through (one level of tax) entity (unlike S-Corporations).

2. The inside basis of appreciated property held by the LLC may be adjusted to FMV upon the death of the deceased owner.

3. LLC owners obtain owner basis adjustments for entity level debt, allowing them to claim entity losses passed through to them (unlike S-Corporations).

4. Distributions in kind of appreciated property from a LLC to its members do not trigger “deemed sale” tax treatment (i.e. gain recognition and taxation) (unlike a S-Corporation).

5. Contribution of appreciated assets to a LLC will not result in gain recognition.

6. Unlike an LLC, a limited partnership must have at least one general partner, subject to unlimited liability. In a LLC, all members will be directly protected against liabilities arising at the entity level under state law.

7. All LLC members can participate in management without losing liability protection (not just general partners in the case of a limited partnership).

8. For cross-border transactions, unlike an S-Corporation, foreign non-resident alien investors may directly join with U.S. co-ventures in a single entity to conduct a U.S. business with pass-through tax treatment for both.

9. U.S. based investors may use a LLC to conduct a foreign business and have limited liability protection and one level of pass-through taxation.

When combined, (i.e. an S-corporation) as the Manager and Owner of the LLC:

1. There is no self-employment tax (Social Security/Medicare) on net earnings distributed ultimately through an S-Corporation. In 2013 the tax savings is $17,396 (15.3% on $113,700, taxable wage base maximum).

2. The LLC may provide a single entity for inbound joint ventures between a U.S. and foreign person.

3. The LLC may hold outbound investment of U.S. based person with limited liability.

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