Can an LLC receive S corp. tax status?

Business owners should keep in mind that LLCs can request S corp. tax status.  This allows your company to remain an LLC for legal purposes but gain the tax benefits of an S corp.  To gain S corp. status, an LLC must comply with the S corp. ownership rules but need not follow corporate formalities.  So, an LLC with S corp. tax status still has more flexibility than a traditional S corp.

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What are the benefits of an S corp.?

When business owners choose an S corp., it’s for the tax benefits.  S corps. are more rigid and require more paperwork than LLCs, but they pay significantly less in employment taxes, which makes a big difference for highly profitable businesses.  S corps. are beneficial because they:

  • Have a lower initial filing fee;
  • Only pay employment tax for employee wages, not their entire net income;
  • Can write off certain employee/shareholder benefits for more savings;
  • Exist in perpetuity, making it easier to continue operating if a shareholders dies, sells his or her shares, or leaves the corporation;
  • Have clearer lines between the business entity and its shareholders;
  • Seem more legitimate to investors, who view the corporate structure as more stable; and
  • The paperwork resulting from required corporate formalities serves as great evidence of prudent business decisions in the event of a lawsuit

The downsides to S corps. are the restrictions, which include limitations on membership, investments, and types of stock.  S corps. must be managed by a board of directors, not the shareholders, and are required to observe corporate formalities.  If an S corp. fails to meet all of its entity requirements, it converts to a C corp. and loses its tax benefits.

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What are the benefits of an LLC?

The title “limited liability  corporation” sounds good to business owners, but what are the key benefits of an LLC?  The main reasons business owners choose LLCs over S corps. are simplicity and flexibility.  S corps. are subject to a number of strict requirements while LLCs are more relaxed, leaving you with more room to decide how to run your business.  LLCs are beneficial because they:

  • Have almost no membership restrictions;
  • May be managed by members or selected managers;
  • Do not require corporate formalities, though some are suggested;
  • Can generally make tax-free distributions of appreciated property;
  • Can make member-level tax adjustments for LLC liabilities;
  • Can allocate tax benefits related to depreciation and losses without regard to members’ proportional ownership interests; and
  • Provide greater protection in the event of a personal judgment against a member.
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What do LLCs and S corps. have in common?

Two key benefits offered by LLCs and S corps. are limited liability and “pass-through” taxation.  Limited liability means that owners generally are not personally liable for the debts and liabilities of the business.  “Pass-through” taxation allows these business entities to avoid double taxation—neither LLCs nor S corps. pay corporate-level taxes.  Instead, all profits and losses are passed through to the business owners and applicable taxes are paid on their individual returns.

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What is joint employment and does it apply to my business?

The National Labor Relations Board considers franchisors joint employers of their franchisees’ employees when they “share or codetermine those matters governing the essential terms and conditions of employment,” such as hiring, firing, discipline, supervision and direction, determining wages and benefits, setting work hours, and ongoing training of franchise employees.  This is a problem for franchisors because joint employment creates joint liability.

To avoid entering a joint employment relationship, franchisors should:

  • Clearly define the franchisor/franchisee paradigm in franchise agreements by plainly stating that the franchisees alone are responsible for decisions related to personnel matters.
  • Maintain a separation of powers with franchisees.
  • Refrain from directing or attempting to give guidance directly to franchisees’ employees during audits.
  • Make sure franchisees post clear notice, visible to both customers and employees, identifying the location as an independently owned and operated business.

For more information on any of the subjects addressed in our FAQ or employment law in general, contact us at (312) 216-2720 or info@marcusboxerman.com.

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Are my workers employees or independent contractors?

Knowing whether your workers are employees or independent contractors is crucial for compliance with wage and hour laws and figuring it out is not always as simple as employers think.

“Independent contractor” is the most common misclassification for employees. Employers are tempted to use this classification for workers because independent contractors are not subject to the usual requirements for minimum wage, overtime payments, unemployment insurance, and worker’s compensation benefits.  However, the Department of Labor has found that the vast majority of workers are employees regardless of how agreements between the employer and worker describe the relationship.

The Department of Labor using the “economic realities” test, looking to several factors to determine whether a worker is economically dependent on the business (an employee) or economically independent (an independent contractor).  Those factors include:

  • Whether the work performed is an integral part of the putative employer’s business;
  • Whether the worker’s opportunity for profit or loss depends on his or her managerial skill;
  • How the investment of the worker compares to that of the putative employer;
  • Whether the work performed requires special skills and initiative;
  • Whether the relationship between the worker and employer is permanent or temporary;
  • How much control the employer exerts over the worker.
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What are the best practices for employee termination?

When you are considering an employee termination, look to applicable employment contracts, your employee handbook, and the employee’s personnel file to find the information you need.  Illinois is an at-will employment state, but employment contracts and the disciplinary practices in your handbook may restrict your ability to terminate without cause.

The employee’s personnel file should contain documentation of all performance and misconduct issues.  Make sure that your employee received an adequate warning that their misconduct could result in termination and that you have sufficient documentation to support your termination decision if the employee decides to take you to court.  If there is not enough supporting documentation, consider whether a different disciplinary action is appropriate.

If you choose to move forward with the termination, offer your employee a severance package in exchange for a release of claims.  By paying a little extra now, you can avoid lawsuits down the line.

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What is employment discrimination and how can I avoid it?

Discriminatory employment practices include bias in hiring, firing, promotion, job assignment, compensation, retaliation, and harassment based on the protected characteristic of an employee.  Employment discrimination may be overt or subtle but is always illegal when based on an employee’s race, color, national origin, religion, sex, age, disability, citizenship status, and genetic information.

In Illinois, it is also illegal to discriminate based on an employee’s sexual orientation, ancestry, marital status, pregnancy statue, or military status.  In the City of Chicago, moreover, it is unlawful to discriminate based on parental status, source of income, or credit history.

To avoid discrimination or the appearance of discrimination, employers must have set policies in place for important employment actions, apply those policies equally to all employees, current and prospective, and document the reasons for employment decisions to make sure they can show a legitimate reason for unfavorable treatment of an employee.

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What are some common compliance issues faced by employers?

Many employers face compliance issues because they don’t realize that compliance begins with the hiring process.  For example, in Illinois, employers may not ask about an applicant’s credit history and are restricted in when they may ask about an applicant’s criminal history.  Employers must also verify employment eligibility by having employees fill out I-9 and W-4 forms.

Employers face issues with federal, state, and local wage and hour laws that govern how much and when employees must be paid.  Plus, they must comply with a number of federal regulations including the Americans with Disabilities Act, the Family and Medical Leave Act, and the Patient Protection and Affordable Care Act.  Employers also have to watch out for employment discrimination issues and properly classify their workers as either employees or independent contractors in compliance with the Fair Labor Standards Act.

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How should I maintain my employee personnel files?

Thorough recordkeeping is the key to defending your decisions as an employer, and employee personnel files are the right place to store important information about your individual employees.  Your documentation should begin before you even hire an employee, recording reasons for your decisions in employment screening and the hiring process.

Once an employee is hired, open a personnel file to store performance review and evaluations, catalog employee performance and behavioral issues, and chronicle reasons for employee separation, whether voluntary or involuntary.  Remember to keep personnel files confidential, only giving access to management to protect your employees’ privacy.

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