Question: I am considering starting a new business and I anticipate that it will produce losses, rather than profits for the first few years. Should I form a limited liability company or an S corporation to own and operate the business?
Answer: People ask this question of me a lot, which is why I wrote a detailed article called “LLCs vs. Corporations: Which Type of Arizona Entity Should You Form?” My article explains the many reasons why I believe that the LLC is the entity of choice in Arizona. People who ask this question are mixing the type of entity formed under state law with a method of taxation under the Internal Revenue Code of 1986, as amended. When you are thinking of forming an entity in Arizona to operate a business or to own investment real property, the first question is what type of entity should I form under Arizona law? Almost always the answer is a limited liability company.
After you form your company, the next question is what is the best method of income tax for the entity? If your tax adviser says that your LLC should be taxed as an S corporation and if it is eligible for that method of tax, then all of the members of company must sign an IRS Form 2553 (the instructions) and file it with the Internal Revenue Service before the deadline for making the S corp election. An LLC taxed as an S corporation is a “pass through” entity (it does not pay income taxes), which means that losses are passed through to the owners who can deduct the losses on their personal income tax returns (if they have sufficient basis). Note: An LLC that elects to be taxed as a C corporation, an S corporation, a sole proprietorship or a partnership for federal income tax purposes does not change its character. The entity always remains an LLC created under Arizona law regardless of the method of federal income tax applicable to the entity.
Bottom line: If S corp tax treatment is important and your business is in Arizona, form an Arizona LLC and cause it to be taxed as an S corporation by filing an IRS form 2553 in the first 75 days after forming the LLC.
P.S. I recommend that everybody who forms an LLC consult with a good tax advisor as soon as possible after forming the entity to obtain advice on which of the four federal income tax methods (sole proprietorship, partnership, C corporation or S corporation) is best for the limited liability company. The election to change the default method of income tax (sole proprietorship or disregarded entity for a single member LLC or partnership for a multi-member LLC) must be filed within 75 days of the date of forming the LLC for the election to be effective from the date of formation. For a list of the Certified Public Accountants I recommend in Arizona see “Professionals We Like.”
To learn why 8,000+ people have hired me to form their Arizona LLC, see “Contents of Arizona LLC Attorney Richard Keyt’s $597 Complete LLC Package” and Testimonials.