Sole Proprietorship vs. LLC vs. S Corp vs. C Corp…Ahhh! It can be so confusing.
Every business owner has had to face this choice. And many have questioned the decision. Countless Google searches have been done on what they are and which one to choose.
But the two that usually float to the top of the list are either an LLC or an S Corp. It’s the question we get the most at Steadfast Bookkeeping.
LLC vs. S Corp What’s the difference
The difference between the two is how you’re taxed. The confusion between the two is that you can be an LLC but you choose to be taxed as an S Corp.
Let’s Define What Each Designation Is
A Limited Liability Company, or LLC, is the most common type of business out there.
An LLC provides you with the same limited liability as a corporation would but they are just about as easy to register for as a sole proprietorship. In most states by becoming an LLC, you are protecting yourself personally should a legal matter arise in your business.
This means that the LLC owner is generally not personally liable for any debts incurred by the LLC business or for most business-related lawsuits.
It’s important to note that an LLC is an entity designated by your state. For income tax purposes, your LLC will either be taxed as a sole proprietorship, an S corporation (if you make that election), or even a partnership if there are multiple owners of the LLC.
An S Corp is a tax election you can make in which your business’s income, deductions, losses, and credits will pass through to shareholders. This is for the benefit of limited liability and to avoid double taxation.
You will still operate as an LLC in your state, but for the sake of federal income tax, you’ll be taxed as an S Corporation.
LLC vs. S Corp – Which is Better
Now that you know the difference between the two, the question is “which one is better”.
There is no blanket choice. Not every LLC should become an S Corp. There are definitely times when it makes sense to be an S Corp over an LLC. It is more tax beneficial. But you can’t really know that until you look at your full tax picture.
Here at Steadfast, we evaluate this and do a full analysis as part of our Tax Planning service. During this time, we look at the profits of the business, other income being made in the household, your tax bracket, as well as other tax circumstances that may impact your final tax bill.
Without a thorough evaluation, it’s really hard to say whether or not an S Corp is the best situation for your business or not.
What about Self-Employment Tax?
You’ve probably heard that when you elect to become an S Corp, you are taxed less because you no longer have to pay that 15.3% self-employment tax.
While it’s true that an S Corp doesn’t pay that 15.3% self-employment tax on profits, you need to know that as an S Corp owner, you are required to take a reasonable salary from the business.
This means the owner will receive actual W2 wages that have taxes withdrawn from their check. When you take that salary, you are taxed on that salary instead of the profits of the business.
Don’t think you can do this and just pay yourself a very little amount to avoid the taxes. And then take super high distributions from the business that “aren’t taxed”. It’s not a good idea.
It’s called a reasonable salary for a reason. A reasonable salary has to be REASONABLE to other salaries in your area with the same job. So, as a CEO, it’s probably not very reasonable to take a $25k salary when most CEOs in your area make $90k.
Taking a low salary and high distributions is a red flag to the IRS and they can actually revoke your S Corp status if they feel you’re taking advantage of the reasonable salary rule.
How Do You Choose?
So, is an LLC vs S Corp better for you? I would recommend reaching out to a CPA who can analyze your individual tax situation and advise you on that. If you make enough profit in your business and plan to take a decent amount of distributions, an S Corp may be best for you. Depending on the other tax circumstances you have.
Sometimes, becoming an S Corp is more work than it’s worth. Many business owners fall into that trap only to find out later that it’s no real benefit to their business. They end up spending more time and money on payroll, additional tax returns, etc than it’s worth.
If you are in a place where you are considering an LLC vs. S Corp and choose which is best for you, please click here to contact us. I’d love to speak with you about our tax planning services. We can help analyze your situation and guide you in the right direction.