Series LLC vs S Corp - Which One Is Right For You?
Hey Everyone, Today’s topic has to do with the business side of real estate and a couple of popular entities that small active real estate investors use. Before we get down to the nitty gritty of everything I want to say that this blog post is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or financial advice related to individual situations. Please consult with an attorney, CPA, and/or other professional(s) about your specific situation. Now that that’s out of the way, let’s dive in!
Real Estate investing involves some risk and if you’re an active investor who buys rental properties, you’re always at risk of being sued by tenants or anyone looking for a settlement. After all, you can spare a few million right? You’re a landlord!
Whether you have millions in cash lying around or are just scraping by, most of the time when people see “landlord” they envision a lavish lifestyle full of private jets, yachts, and evil cackling while greedy property owners sit in their Scrooge McDuck vaults and swim through piles of cash.
Whatever your personal situation is, it’s important to think about protecting your personal assets from business liabilities. The best way to do this is to separate your business from your personal affairs with a separate entity.
There are many different business entities one can form, but two of the most popular among small active real estate investors are the S Corporation (or “S Corp”) and the Series LLC. But which one is right for you? There are many similarities between S Corps and Series LLC’s, but there are some very important differences as well.
Before we go any further, one important distinction to make is the difference between tax status and entity type. When speaking about S Corps and Series LLC’s, I’m referencing both components. An S Corp is a Corporation(entity type) that has elected to be taxed as an S Corp(tax status). A Series LLC is an entity type that by default is taxed as a pass through entity, meaning all income from the LLC is “passed through” to the owner as income, unless the owner elects to have the LLC taxed as a corporation.
Important Difference # 1 - Management
A board of directors and officers must manage an S Corp whereas the owners of a Series LLC may hire someone to manage the business, or do it themselves.
Important Difference # 2 - Ownership
S corps are owned by shareholders, as are all corporations. Series LLCs are owned by members. Either can have only one involved person, IE a single member LLC, or a corporation where one person owns 100% of the outstanding shares.
There are a few restrictions when it comes to S corp ownership though. The IRS states that
S Corps may not have more than 100 shareholders
Only U.S. citizens or residents are allowed to be S corp shareholders
Partnerships, corporations, LLC’s, and many types of trusts are not allowed to own S corps
On the flip side, Series LLC’s can have an unlimited number of members and may have an unlimited number of series and subsidiaries.
Important Difference # 3 - Formalities
There are a lot more formalities required when dealing with an S corp, or any type of corporation. These formalities are statutory and required to maintain the status of corporation. Some common formalities include:
Recording minutes during meetings
More stringent record keeping procedures
Shareholders meeting - often required at least once annually
Formation and adherence to bylaws
Issuance or sale of stock and/or shares
These formalities are not required by a Series LLC, however LLC’s are required to have an operating agreement and it is recommended that this agreement be followed, that annual meetings be held, and that accurate records are kept to maintain the asset protection benefits associated with holding a Series LLC.
We’ve talked about the differences, but there are some similarities between the two as well.
Important Similarity # 1 - Taxation
Unlike C Corporation tax status, S corporation tax status is pass through where business income is recorded on the shareholder's personal tax return. The company does not pay corporate tax and the shareholders pay tax at whatever their personal tax rate is. Series LLC’s are taxed the same way (unless they elect C Corp status). This can be a benefit because C Corporations are subject to what is known as “double taxation.” This means that the corporation pays tax on it’s profits and shareholders must then pay personal income tax on the dividends they receive. While this tax status has its uses, it is often not the best choice for small active real estate investors.
Important Similarity # 2 - Liability Protection
S Corps and Series LLCs are seen as separate legal entities that are distinct from their owners. This holds true whether there is one owner or hundreds. Owners are not liable for business debts or judgements against the business. As a result business creditors cannot take the personal assets of owners and lawsuits are limited to only the assets that are held by the entity being sued. With a Series LLC, there is asset protection between series. This means that if one series is sued, the losses are limited to only that series and the entire LLC is not at risk.
It is important to remember though that this asset protection is only extended as long as a separation of business assets and personal assets is maintained. If a business owner keeps poor records and routinely uses business cash to pay for personal expenses and vice versa, a court may find enough evidence to “pierce the corporate veil” and hold the business owner accountable by ruling that because there was no meaningful separation between the owner and their business, the owner is liable for business debts or lawsuits.
So which one is right for me?
The answer to that question is not one that I can give you. The answer will depend on your personal situation and how you want to run your business. Each has its pros and cons even though on the surface they offer many of the same benefits. I always recommend consulting a lawyer or CPA before making any major financial decisions.
Another option to consider is investing passively in real estate through a syndication. As a limited partner in a syndication, one is often allowed to benefit from the tax benefits of owning commercial real estate and the passive income generated while not having to take an active role in management. In addition, a limited partner is not responsible for any liability, even business liability, and their exposure to a deal’s risk is limited to the amount of money invested in that specific deal.
As always, if you are interested in learning more about real estate investment, feel free to reach out to us here at IronGall Investments. We would love to connect and learn how we can help you achieve your goals.