LLC vs S Corp
- Strategic Tax Accountants
- Oct 24, 2022
- 2 min read
This week we will be discussing and de-mystifying the difference between LLCs and S-Corporations.
This is a hot topic for many -- I know a lot of you have heard about the benefits of changing your business into an S Corporation, but some of you might not know all the details.
We're breaking it down to fundamentals so you can make an informed decision for your business!
LLCs
Alrighty, so let’s briefly go over Limited Liability Companies. An LLC is a legal structure, which allows one to own and operate a business, viewed as separate from its owners (members).
Business Structures include your:
Sole-proprietorships
A sole proprietorship is a type of business that can be operated and owned by an individual, a corporation, or a limited liability partnership. There are no business partners. A sole proprietorship's legal position can be characterized as follows: It is not a separate legal entity from the owner of the company.
Partnerships
A partnership is a legal agreement between two or more people to oversee and run a business and share in the profits.
There are several forms of partnership agreements. In a partnership business, for example, all partners share responsibilities and earnings equally, but in others, partners may have restricted liability. There is also the "silent partner," who is not engaged in the daily activities of the company.
Corporations
A corporation is a commercial entity whose shareholders elect a board of directors to manage the organization's operations. The corporation is responsible for the company's activities and finances; the shareholders are not.
LLCs
A limited liability corporation (LLC) is a type of business structure that allows for limited liability and pass-through taxes. The LLC, like corporations, legally exists as a distinct entity from its owners. As a result, owners are rarely held personally liable for the company's debts and obligations.
This “separation” is also true of Corporations, another type of entity. However, an LLC’s profits and losses are passed-through its members -- the members report this on their tax returns, and are taxed on the Individual level. Corporations are taxed directly, as if they were another person.
This also protects an LLC member’s assets in the event of a lawsuit or debt -- only the business’ assets can be touched, since the members are viewed as separate in the legal sense.
These details make LLC’s the most popular and flexible choice for entrepreneurs and investors.
S-Corps
Now for S-Corps: an S-Corporation is not a business structure -- it’s a tax classification. LLC’s and Corporations can choose to be taxed as a:
Sole-proprietorship (for Single-Member LLCs)
For income tax purposes, an LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and affirmatively elects to be treated as a corporation. However, for purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.
An individual who owns a single-member LLC and performs a trade or company is taxed on net profits from self-employment in the same way as a sole proprietorship is.
If the single-member LLC is held by a corporation or partnership, the LLC should be reported as a division of the corporation or partnership on the owner's federal tax return.
Partnership (for Multiple Member LLCs)
A limited liability corporation having two or more members is known as a multi-member LLC. A multi-member LLC (MMLLC), like a single-member LLC, is a lightweight business form that combines the freedom of a partnership with the limited liability of a corporation.
S Corporation
For federal tax purposes, S companies chose to pass through company income, losses, deductions, and credits to their shareholders. S company shareholders report the flow-through of earnings and losses on their personal tax returns and are taxed at their individual income tax rates. This helps S firms to avoid paying double taxes on corporate revenue. S companies are taxed at the entity level on certain built-in profits and passive income.
C Corporation (traditional Corporation)
A C corporation (or C-corp) is a corporate legal form in which the owners, or shareholders, are taxed separately from the company.
A company's profit is taxed to the corporation when it is earned and then taxed to the shareholders when it is dispersed as dividends. This results in a double taxation. When a business delivers dividends to its shareholders, it does not receive a tax deduction. Shareholders cannot deduct the corporation's losses.
Both an LLC and S-Corp pass-through their profits to the individual member(s), thus the profit is itself not subject to Income Tax -- both entities’ taxes are paid at the Individual level.
For an LLC, you will be taxed on all income made in your business. The IRS assumes that all business profit has been paid to you. At an individual level, members are responsible for:
Federal & State Income Taxes
Self-Employment Tax -- 15.3%
Taxes that are withheld for you in a paycheck with normal employment.
When you choose for your LLC to be taxed as an S-Corporation, you avoid Self-Employment Tax on Distributions paid to the owner(s). But the members DO pay Self-Employment Tax on the Salaries paid to them.
With the structuring of S-Corp, owners must classify themselves as employees of the business -- and pay themselves a reasonable Salary. This income IS subject to Self-Employment tax.
However, outside profit (Distribution) paid to Members is NOT subject to Self-Employment tax.
So -- within reason, because the IRS will not play games -- if you pay yourself a more modest Salary, but a higher Distribution, you can reduce taxation in the scope of an S-Corp.
These benefits make it sound like a no-brainer. That every business should just go and have themselves taxed as an S-Corp. But you shouldn’t go and sign up for this without consideration:
Business makes enough profit to pay both distribution/salary.
If your Distribution wouldn’t be more than $10k, it may not be worth the effort.
If you don’t plan on reinvesting those profits into the business.
All surplus profit would be taken away from the company, paid to its members.
Then, individually taxed.
If you plan to reinvest profit into the company during the same year, stay an LLC
Avoids unnecessary Income & Employment taxes --> goes into Expenses
If you plan to reinvest your profits into the business over a period of time (not immediately) you could elect to be taxed as a C-Corporation.
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