LLC vs. S-Corp
What is an LLC:
LLC means “Limited Liability Corporation.” The purpose of forming an LLC is to shield a business owner’s personal assets if the business is ever sued. A single-member LLC has one person who is in full control over the company. In a multi-member LLC, you will need to determine what percent each member holds and each other’s rights in the event of a spit-up, death, or an irreconcilable disagreement.
What is an S-Corp:
An S-Corp has tax benefits while still providing the legal liability protection that comes with an LLC. With an S-Corp, the business’ profit and losses are passed through to the shareholders and are included on individual tax returns. For a single or 2-member LLC, it’s mostly about taxes.
Taxation- LLC vs. S-Corp:
For tax purposes, A single-member LLC is easier because no federal tax return is required and instead is taxed like a sole proprietorship unless you decide to convert to an S-Corp for tax purposes. For a single-member LLC, the income is reported on the member's tax return. A multi-member LLC must file tax returns. Profit and losses are allocated to each member regardless of whether members receive any actual money. Even if members don’t take money out of the business, they still report their share of the profit and pay taxes on it.
Default LLC Taxation:
If you form a multi-member LLC and do not file any special form with the IRS, the LLC will be taxed as if it were a partnership. Regardless of whether you have a single-member or a multi-member LLC, you can choose to have it treated as an S corporation by filing IRS. An accountant can tell you if your company generates enough profit to make the change in tax structure worth it.
S-Corp taxes:
Forming an S-Corp can help you to save money on self-employment taxes. This is because as an S Corp owner, you aren’t really self-employed–you are an employee of the company and pay yourself “reasonable compensation” typically done using a payroll company or software. Your salary will still be subject to Medicare and Social Security taxes, but any company profits over and above your salary will not.
Reasonable Compensation:
There’s no federal guideline for reasonable compensation, but the IRS looks closely at S-Corp owner salaries and reasonableness is based on standard salaries in your industry, geographic location and your experience. It’s always a good idea to talk to an accountant when determining owner-employee salaries. The business pays payroll taxes on the owner-employee’s wages, and the owner-employee also pays payroll taxes on their business owner salary. Owner-employees also have federal income tax withheld from their paycheck.
Disadvantages of an S-Corp:
Disadvantages of an S-Corp include an increase in accounting fees (more complicated tax withholdings), payroll expenses, and separate tax filings. Many companies chose not to form an S-Corp until the income is high enough to make sense from an accounting perspective.
Accountant & Deadlines:
You may want to discuss the benefits of forming an S corporation with an accountant to ensure it is the best for your business and personal taxes. You have 2 months and 15 days from the date of your entity formation, or you’ll have to wait for the following tax year.
