S Corp v single person LLC?

Question

Please advise if you think a business would be less likely to be audited if it were a S Corp, compared to being a single person LLC.

I had it explained to me this way - If you operate as a corporation, the IRS must come to you to conduct an audit, but as a single person LLC you file a Sch C with your 1040. Therefore as an individual filer you are required to go to the IRS for an audit.

So it costs the IRS more to conduct an audit off site (1120/1120S) than it does in their offices (1040). As a result, given two similar businesses, the IRS is more likely to audit the one that files on a 1040.

Does that seem logical, or from experience, have you found that it doesn't really matter?

Answer 1

From a tax standpoint their is no difference. An S-Corp is a pass-through entity where the total profit for the year passes directly to the shareholders personal tax returns. An LLC is a disregarded entity for Federal tax purposes so the income and expenses are recorded on Schedule C as if you were a Sole Proprietorship.

Audits are based upon a statistical analysis of the numbers on your return. If any area is out of limits for similar returns your odds of audit increase. The legal manner in which the business is established has no bearing on this. Just because you're a corp does NOT mean that all audits are automatically field audits. And an LLC can be the subject of a field audit as well. The question the IRS asks is, "Is there a good chance of getting more tax, and if so, what are the odds of doing so?" The answer to THAT question determines the scope of the audit, nothing else.

From a state tax standpoint an S-Corp and an LLC are identical and typically require the filing of a corporate tax return and payment of the minimum franchise tax regardless of the income or loss involved. That can run as high as $800 in some states, CA for example.

There are no meaningful tax benefits to an S-Corp or LLC. The only thing that either do for you is protect your personal assest (home, investments, etc.) from liability claims against the business. If you have substantial wealth they may be worth it especially if you are running a risky business such as a medical practice. If you're not in a risky line of business, a good commercial liability insurance policy will usually provide adequate protection and cost less in the long run.

Answer 2

That's a new one on me. I have never heard that before and personally, I do not believe it to be true.

I did read that the IRS just finished up a sample audit of 5000 S-Corps. The owners of 85% of these S-Corps had their tax bills increased (mostly due to too low of compensation). Due to this sample and its results, the chances of having a S-Corp audited have increased greatly.