What are the Tax Advantages of an LLC vs an S-Corp?

By January 20, 2015 July 14th, 2017 Taxes

For entrepreneurs, the way a business is structured plays a key role in how it operates and how it is taxed. To help you better choose between a Limited Liable Company (LLC) or an S Corporation (S-Corp), the tax advantages of an LLC vs an S-Corp are important facts to consider. 

LLC Advantages:

  1. An owner of a single member LLC is not required to file a tax return for the LLC, being that one’s business activity is reported on their personal tax return.
  2. Three options are available for filing taxes. Single-owner LLCs are taxed like sole proprietorships, with owners attaching a Schedule C form to their personal tax returns. LLCs with multiple owners are taxed like partnerships, with owners filing a form 1065 partnership tax return. You also have the flexibility to choose to have your LLC taxed as an S-corporation.

LLC Disadvantages:

  1. LLC owners are liable for self-employment taxes. Owners working directly in the business must pay these taxes on the full amount of their profit, up to $117,000.  Any profit earned above this amount is taxed at the medicare rate of 2.9%.
  2. LLC owners need to operate the business separately from their personal affairs. Failing to do so could lower the liability protection for the owner.
  3. Cash held in the company is taxed even if it’s not withdrawn by the owners.

S-Corp Advantages:

The primary tax benefit of using an S-corp is that a business owner can distribute funds to himself without paying medicare or social security taxes on it. The IRS monitors this carefully so it is important for the business owner to pay himself a reasonable salary for the services he performs for the business. Once the salary is determined, consider the tax savings in the example below of the same company taxed as an LLC versus as S-Corp:

LLC Example

  • Company Name: Isaveontaxes LLC
  • Revenue: 200,000
  • Profit: 100,000
  • Self Employment Tax: 100,000 * 15.3% = $15,300

 

S-Corp Example

  • Company Name: Isaveontaxes LLC
  • Revenue: 200,000
  • Profit 100,000
  • Salary: 60,000
  • Employment Tax: 60,000 * 15.3% = $9,180
  • Estimated Payroll Costs: $600
  • Estimated Additional Tax Prep Costs: $500
  • Total Cost: $10,280
  • Tax Savings: $15,300 – $10,280 = $5,020

In the example above, if the owner’s salary is considered reasonable compensation, then he saves ~$5,000 in payroll taxes by being taxed as an S-corp.

S-Corp Disadvantages:

  • S-Corps are more difficult to organize than LLCs. Per the tax code, you must meet the following requirements to create an S-Corp

    – Must be a U.S. citizen or resident.
    – Cannot have more than 100 shareholders.
    – Corporation can only have one class of stock.
    – Profits and losses must be distributed to the shareholders in proportion to the shareholder’s interest.

  • Investing S-Corp owners are taxed personally on their share of the profit. Working S-Corp owners can be given their share of profits as additional compensation (with extra payroll taxes due) which adds to their personal income.
  • There are very stringent requirements for foreigners to be owners of an S-corp.
  • Owners must receive distributions in proporation to the ownership percentage.
  • Additional state taxes can apply; depending on what state you reside or operate.

Understanding the pros and cons for operations of an LLC vs. an S-Corp are also important, and a few are listed below.

Additional Pros and Cons of S-corps and LLCs

LLC:

  1. Most LLC forms are only a single page for single member LLCs.
  2. The cost of setting up an LLC is inexpensive.
  3. The red tape restrictions in forming an LLC is not as strict as forming an S corps, This does allow less separation of business and personal assets, but costs like accounting, attorney fees, and setting up an LLC are significantly less.

S-Corp:

  1. Forming an S-Corp costs more than an LLC.
  2. Avoids double taxation, unlike normal corporations (C-Corps).

Because tax requirements can sometimes be confusing, I hope this post is helpful to you in making a decision between forming and LLC or an S-Corp for your business.

If you have any questions, post them in the comments below.


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