Instead, they’re usually taxed in the same way as sole proprietorships or partnerships, depending on whether the LLC has one owner or multiple owners. However, an LLC can also elect to be taxed as an S corporation (if it qualifies) or a C corporation (C-corp). S corp tax classification might be best for your business if you have plans to scale. S corporations require additional tax forms and payroll systems, which might not be worth the hassle if your business breaks even or makes a small profit. With an S corporation, you can contribute more money to retirement plans and position your business for growth. Regarding management structure, LLCs and S corporations differ in several ways.
By default, LLCs can be taxed as sole proprietorships or partnerships, depending on the number of members. This means that the LLC's income is passed through to the owner's tax return, and the owner is responsible for paying taxes on the profits at their tax rate. On the other hand, S corporations offer pass-through taxation, which allows corporate income, losses, deductions, and credits to flow through to the shareholder's self-employment tax tax returns. In contrast, an S corp permits you to categorize part of your income as dividends or distributions. While the business still avoids corporate income taxes (similar to an LLC), the significant advantage is that income earmarked as dividends is exempt from both self-employment and payroll taxes. Companies with an annual profit of $80,000 or greater may find that electing S Corp status can result in tax savings.
Liability
Only individuals and certain trusts can be owners of an S-corp, Paris explained. An LLC can have an unlimited number of members, while an S-corp can have up to 100 shareholders aka owners. However, it's important to remember that not all companies are eligible to be S corporations, and certain shareholder limitations need to be considered. LLCs and S corporations are different aspects of business operations but are not mutually exclusive. Use this guide to learn more about the difference between an LLC vs. an S corporation. In this example, by opting for an S Corp, the consultant could potentially save $17k in taxes.
- Ultimately, it’s best to talk to an accountant or tax advisor to see which option is best for you.
- You may opt to have your LLC taxed as an S corporation by filing Form 2553 to be treated as an S corporation.
- If you can’t pay your business debts, creditors can go after your personal assets, including your home, savings, and investments.
- Understanding them can save you and your company time, money and potential headaches in the future.
- The shareholders of the S corporation would report the flow through of income and losses on their personal tax returns.
After electing S corp status, an LLC owner uses profits to pay salaries and distributions to owner-employees. The business must be able to cover a reasonable salary and at least $20,000 in distributions for the S corp election to make financial sense. LLC owners also have what is called “limited liability protection.” This means that they are not personally liable for certain debts or liabilities incurred by their LLC. For example, if an employee of an LLC is injured on the job and sues the company, the owner’s personal assets are protected from being used to pay any judgment against the company.
The adjusted gross income (AGI) of $95,741 is then reduced by a standard deduction of $12,000 to give a taxable income of $83,741. The total tax is calculated, and then subtracted from the AGI to yield the after-tax income. Therefore, while S corporations can provide significant tax advantages over sole proprietorships through reduced self-employment taxes, various factors influence this potential benefit. Always consider consulting a tax professional to identify the best fit for your specific situation.
A LLC is a separate legal entity formed at the state level.
To do this when first forming your LLC, you will need to file your declaration with the IRS no later than 75 days after the date the business is formed. This will allow the business to be taxed as an S corporation during the initial year the business is operating. If the form is not sent in time, the tax status will not take effect until the following tax year. When taking advantage of this loophole in the tax code, you must make sure to take a reasonable salary in addition to your distribution. Sole Proprietors and partnerships are covered by an employment tax called SECA, while S Corp owners pay into a similar program called FICA. However an S Corporation, because they pay your salaries like a W-2 employee, also have extra payroll taxes such as unemployment insurance.
LLC vs S Corp: Which is Better for Your Business?
To convert an LLC to an S corp, you'll need to file Form 2553 with the IRS. LLCs and S corporations are different aspects of business structure. Pursuing one, both, or neither classification could benefit your business differently. Consider your needs when running a business, and ask yourself the following questions to understand better which designation is right for you. The average cost of filing articles of incorporation, not including lawyer fees, ranges from $100 to $250, depending on the particular state you file in. If you do business in other states as an LLC, you'll need to register to conduct business in each state, which will cost an additional foreign business registration fee.
Should I pay myself a salary from my S corporation?
Further, the S corporation cannot be owned by any other corporate entity. This limitation includes ownership by other S corporations, C corporations, LLCs, business partnerships, or sole proprietorships. In other words, the personal assets of the owner cannot be used for legal claims against the business.
How to Save Thousands with an S Corp
The S Corp election process involves completing IRS Form 2553, which requests the IRS to consider the entity as an S Corp for taxation. This form must be filed within 75 days of filing the business formation documents with the appropriate state agency. If not met within the time limit, the S corporation tax status will have to wait until the next year or file a request for late election relief with the IRS. It’s worth noting that electing an S Corp tax status involves compliance with more rigid rules and regulations—a critical consideration when deciding on the tax structure of a legal business entity. In most situations, enterprises can save the greatest amount possible by structuring the business as an S corporation. This is an option for S corporations and limited liability companies that decide to be taxed like an S corporation.
The disadvantage of an S corp (in comparison to an LLC) is that it offers less autonomy when it comes to how revenue can be invested, and is also more expensive to maintain. Alternatively, you can have a look at the IRS’s Form 2553 Instructions page or check out our state-specific How to Start an S Corp guide for more information. Before we explore the main differences between LLCs and S corps, it's essential that you understand what each of these actually are. Issuance of stock for the S Corporation can be in the form of common or preferred stock. However, please check with your local state since they may have additional forms and requirements.
How to choose between an LLC and an S corp
Earned income is further comprised of your total ‘net farm income or loss’ and ‘net business income or loss’, which is then adjusted downward by 92.35%. This adjustment is to compensate for the total employment tax that would traditionally be paid by an employer if you were not self-employed. Remember, if the adjusted amount is less than $400.00, you don’t have to pay self-employment tax on this income.
Unlike a C Corporation, an S Corp still enjoys the pass-through tax filing that partnerships pay. LLCs are what’s called “pass-through” entities, which means that the business itself is not taxed. Instead, the profits and losses are “passed through” to the owners, who then report them on their personal tax returns. As a business owner, you want to choose a business structure that will minimize your personal liability. An S corporation is a separate legal entity from its shareholders, meaning that the shareholders are not held personally liable for the debts and liabilities of the corporation. This is in contrast to sole proprietorships and partnerships, where the owners are personally liable for the debts of the business.
