E2 Visa Common Questions: LLC vs. Incorporation
Angie: Hi, everyone. Thanks so much for joining us. I’m Angie Rupert, founder of Rupert Law Group. And thanks for joining the E2 Visa Common Questions series presented by me. Today, we’re going to be talking about LLC versus corporations, the tax benefits and disadvantages to each. Again, I’m your host, Angie Rupert, founder of Rupert Law Group. We focus exclusively on each E2 visas. We handle E2 visas from every treaty country in all 50 states. So, wherever you are, and wherever you want to be, we can help you with your E2 visa and joining us today to go over LLCs and incorporations, Dan Schwartz. He is a CPA and attorney. Thanks so much for joining us, Dan. Appreciate your time today.
Dan: Thanks for having me.
Angie: So, Dan is certified in tax and estate planning and he focuses on income and estate tax compliance and planning for high net worth individuals and closely-held businesses and trusts. So, if there’s anyone that can give us tax advice, it’s gotta be Dan, right?
Dan: Thanks for having me. Thank you for the introduction. I have a unique practice. I don’t know a whole lot of people that do what I do, but I practice as both an accountant and an attorney. I do tax returns and I also do tax business and estate planning legal work. And to top it off, I also act as a trustee for clients who need a private trustee for their trusts.
Angie: Look at that. He does it all. Could you want anything more? And you’re a CPA /tax attorney. I love it. So, Dan, we’re going to talk a little bit today about LLCs and incorporating. So, a lot of my clients are foreign nationals coming here to start a business in the United States. And that’s one of the questions they say, well, should I start an LLC? Should I start a corporation? What’s a C corp? What’s an S corp? So, I guess basically, could you give us a little bit about the differences between LLC, C, and S for like tax purposes?
Dan: Sure. So, we can think of all of these entities as different buckets. So, in one bucket, we have disregarded entities, in another bucket we have pass-through entities, and another bucket we have the double taxation regime of C corps. So, if you are an individual that’s coming here to start a business, you could become or you could form an LLC, and that would be a single-member LLC. And that would be classified as a disregarded entity, meaning it doesn’t file a tax return, there are no taxes on it. You simply report the income and the expenses of the LLC on your tax return on your Form 1040, Schedule C and you pay tax and it’s as though the business doesn’t exist, it’s disregarded. If there’s more than one person, that LLC is treated as a partnership for tax purposes, and it files a tax return Form 1065. And each partner will then get a Schedule K-1, which they then report on their tax return and pay their share of the tax. And so, that two or more member LLC is in that second bucket. The pass-through entity. The income passes through.
Also, in that bucket is an S corporation, which is just like a C corporation, except you’ve elected pass-through treatment under Subchapter S of the Tax Code. This one’s a little tricky though because non-residents are not allowed to be an S corp owner. And there’s that first year when you first come here as a visa holder where you may not be a resident yet. So, that’s something that you need to evaluate with your tax advisor to see if this is a prudent choice for you. But an S corp if it does work or for when you’re here and if you elect S corp treatment, it acts sort of like a multi-member LLC, it’s a pass-through entity. And the owners get a K-1 where they pay the tax on their individual tax return. The benefit of the S corp as opposed to an LLC, is that anything that you don’t pay yourself as a salary because you are required to have a reasonable salary with corporation, anything you don’t pay yourself is free from social security and Medicare tax. And so, a lot of people elect to form an S corp and they pay themselves the bare minimum of a reasonable salary and they save tax that way. And another benefit is that you get the income off of your individual return. So, if you are a sole LLC member, that income is showing up on your Schedule C and that’s a very highly audited form. But if on the other hand, you are a single-owner S corp, the income and expenses of the business are showing up on a business tax return and you just simply report your income on a K-1. So, a lot of people are happy to get the scrutiny off of their individual return, move it over to a non-highly audited form, like the S corporation tax return.
And in the last bucket, we have the double taxation regime of a C corporation. And when you think of a business or you watch TV and they talk about corporations, this is what they have in mind. All the publicly traded companies are C corporations and they have two layers of tax. The corporation files its own return, pays its own tax, and then when it distributes out the profits to the owners, it does so in the form of dividends and it gets taxed twice as a dividend on the owner’s tax return. And with the reduction in the corporate tax rate with the recent tax law starting in 2018, the difference between the one layer of tax and the two layers of tax has gone down, but it’s still significant enough where an owner of a C corporation generally pays themselves a salary to zero out the income of the corporation. So, the corporation never pays tax. The owner just pays tax on their wages.
Angie: So, it’s just as easy as that. Good. Now, go do it, right?
Dan: Well, and even further, if you have an LLC and you decide you want to have S corp taxation, you can always select that. Or if you have a C corp and you want to elect S corp taxation, let’s say you are a resident, you can elect for your C corp to now be treated as an S corp. The important thing to keep in mind is that they do have different legal operational requirements, and they do have different levels of headache. Corporations, you have to pay a salary. LLCs you don’t unless it’s elected S corp status. So, there’s just a lot of considerations here. There are tax benefits, which I know we’re going to get to in the next slide between these entities. So, you definitely want to sit down and talk with your tax advisor instead of just choosing an entity out of the air and going with it.
Angie: That’s a really good idea because, you know, as we’ve learned in the last couple of minutes, and most people probably are already aware you know, United States tax code is a wild place and it’s really not a place for somebody who has no experience and has never lived here. So, you’d want to hire an attorney and/or a CPA who can really talk with you about your goals, right? And what it is that you’re trying to do with this business in order to advise you as far as for tax purposes, which is best for you, right?
Dan: Absolutely. And you should also consider that if you have ties to your former residence in another country, and you have an ongoing business, you know, maybe in other countries or all over the world, you definitely want to sit down with someone who understands worldwide taxation and to plan what the best entity is for you. Not what you saw in this video or what you saw on another YouTube video, what’s best for you because every country is different there’s different tax treaties with different countries. So, it’s not a one-size-fits-all at all.
Angie: That’s absolutely the case and the case with immigration as well, right? So, everybody’s kind of got their own plan and what it is that they want to do in their long-term goals. So, you know, simply just kind of, we’ll just do an LLC and here we go and whatever, sometimes that can backfire a little bit. Not only just with the entity formation, right, but also with taxes. So, I want to talk a little bit about some of the tax advantages or disadvantages for an LLC and a C corp or an S corp as well. But I’m hoping I can ask one additional question that’s not even written here, but is there someone, and I know that we just talked about that it’s kind of a case by case basis, but is there someone knowing that a C corp is double taxation and there might be some additional kind of headache, is there anyone that a C corp would be like the best choice for, like, and who would that be?
Dan: So, the benefit of a C corp is that you can get a deduction for 100% of your health insurance and your medical costs, whereas you can’t get as great a treatment with the other entities. With an S corporation, yeah, you can deduct your health insurance in a very roundabout way prescribed by the IRS, but you can’t deduct your health…I’m sorry, your medical costs. Your out-of-pocket medical, your chiropractor, everything that, you know, welcome to America. We have really high out-of-pocket medical costs. So, with a C corporation and you know, this might change if you have employees and so, there’s rules that you have to follow, but generally, all things being equal, if you are the only owner or employee, you can write off all of your health insurance, all of your medical, and that would for some people be a very high amount, and that would produce a lot of tax benefit.
Angie: That’s really good to know. I didn’t know that either. So, somebody maybe who has, yeah, like some health issues that are not super, you know, maybe not life-threatening, hopefully, but you know, that they know maybe they have diabetes or something where they’re having a lot of care and they know that that’s gonna be something, it might be a consideration, it sounds like.
Dan: Definitely if you have preexisting conditions, but again, welcome to the United States of America where you might spend $20,000 on your family’s health insurance and it’s still not very good. It still has a very high deductible. You know, your deductible…and especially if you’re not working for a big company, your deductible could be $6,000 to $10,000 per person. So, you could be out of pocket easily $40,000 to $50,000 without even blinking. Just on health insurance and out of pocket medical, if you you know, break your leg and go to the hospital, that’s $10,000 right there. Unless you know the doctor and they treat you in the garage. So, [inaudible 00:11:54] that have a family that isn’t covered by a very good group plan, you know, from a big company, might want to look at a C corporation. It’s not a very popular choice and I think people gloss over it because LLCs and S corporations are easier in a sense, you don’t have to plan for your net income when you have an S corporation or an LLC, the income just passes through. Getting to your questions, what are the advantages and disadvantages, with a C corporation, it’s a big headache. You have to have good books, includes a balance sheet as well as an income statement. And if you’re wrong at the end of the year, and you didn’t zero out your income by taking a salary equal to your net income, well, you now have double tax. So, you have tax at the corporate level. That could be 30 something percent with federal and state taxes. And then when you take a dividend, if you do take a dividend from the company, that’s another 20% to 30%, depending on your tax rate.
So, you have to be careful. You have to do tax planning at the end of the year. Keep good books, pay yourself a salary. All of the things incur costs. And for some people, it’s worth it to incur that cost and for others, it’s not. So, it’s again, case by case basis. With an S corporation, I think I mentioned before, you save taxes by not paying yourself as big a salary as you would with a C corporation. The IRS doesn’t like that. So, the one thing that anyone who has an S corporation should be aware of is that you can’t pay yourself nothing and just save on social security and Medicare tax on 100% of your net income. Because remember it passes through, you’re always going to pay the income tax, but with the S corporation, you save on the social security and Medicare tax for anything that’s not paid out as a salary. So, if you make $100,000 in your S corporation and you don’t pay yourself a salary, you don’t pay social security and Medicare tax on that $100,000. But then the IRS is going to come in and slap your wrist and say, you know, you really should have taken a $75,000 salary and only 25% of that was social security and Medicare tax-free. The other 75%, we’re going to come in and levy those taxes.
So, it’s important to pay a reasonable salary. What is reasonable? There’s a very long list of factors. It’s sort of like a duck, you know it when you see it. If it quacks like a duck and walks like a duck, it’s a duck. So, a lot of people will pick a number out of the air and that’s probably not the right thing to do, but it’s better than nothing. But you should, again, talk to your tax professional to evaluate what a reasonable salary is so that you can stay out of trouble. And that’s the number one benefit of the S corp other than not having your Schedule C, which is one of the disadvantages of an LLC if you’re a single-owner. With an S corporation, you still do have to pay a salary, so there’s the cost there. You do have to have a good set of books, balance sheet, and profit and loss. But with both corporations, S and C, you have to do minutes every year in order to maintain corporate formalities. And corporate formalities is a code for not treating this company like your back pocket, you have to treat it like a real entity so that if you get sued, the court doesn’t say, “They didn’t respect this company. We’re not gonna respect their limited liability shield.” And so, the reason you form a business entity, [inaudible 00:15:40] many people and [inaudible 00:15:43] other reasons for E2 visa holders is to obtain that corporate limited liability shield.
So, you know, C corporation is the most intensive in terms of energy and headache. S corporation is a little less so, and then LLCs are by comparison, easy. If you’re a single-member LLC, there’s really no tax savings other than you don’t have to pay for a tax return, it’s all on your individual return. So, 100% of what you make is subject to self-employment taxes, the social security, and Medicare tax, but it’s easy. There’s no salary. You don’t even have to have good books. You just have to have profit and loss to be able to report it on your income tax return. You don’t have to have a balance sheet. And in fact, it’s a disregarded entity. So, there really are…there is no capital count. It’s just, you know, your assets and your liabilities are held within that entity. So, but it does provide you limited liability and you shouldn’t treat it like your back pocket. You should treat it like a real entity. And on the other hand, if you have more than one owner and you’re an LLC, it’s essentially it is treated as a partnership for tax purposes, and you don’t have to pay a salary to the owners and you don’t have to do minutes, so it’s easier than a corporation. And a lot of people like LLCs just because there’s less [inaudible 00:17:09].
Angie: Yeah. You know, you mentioned that you don’t have to pay yourself a salary for an LLC. So, for immigration purposes, you do need to pay yourself a salary. So, there’s kind of a couple of different levels in there, but the great news is it sounds like based on what you’re telling me from a tax perspective, there’s not going to be, you must have whereas the C corp, it needs to be a reasonable salary, you can kind of pay yourself as you see fit. Is that accurate?
Dan: You can take money out of the company as you see fit with both an LLC and I’m sorry, an S corp. You cannot take it as you see fit from a C corp, because that would be a dividend and that would produce double taxation.
Angie: Right. So, you gotta be careful. And then as we mentioned, the S corp may not be a great option for some of these E2 visa holders if you’ve never lived in the United States and some different things. But, great. So, just as clear as that, super simple, right? So, for people, as you can see, Dan’s a great resource for all tax-related questions and that type of thing. As he did mention, there are tax specialists out there that really focus on the different treaties between the United States and your country, every country has a treaty. So, something to keep in mind. But that wraps it up for today. So, here’s Dan’s contact info and there’s me. And Dan and I have known each other for a long time and happy to refer back and forth and help you with your tax or E2 visa questions. And thanks so much, Dan. It was great having you, I appreciate your time.
Dan: Thank you. Thank you.