Corporation vs LLC Tax Benefits: Everything You Need to Know
When comparing corporation vs LLC tax benefits, there are a number of factors that you should consider.3 min read
2. How Are an LLC and an S-Corp Taxed?
3. S-Corp vs LLC: Tax Benefits
Compare LLC vs S-Corporation
If you are starting a business or are considering a change in business structure, you should compare the benefits of a limited liability company (LCC) and an S-corporation. Although these two structures share many similarities, they also showcase key differences.
When you are first starting a business, it is often advised that you begin by forming an LLC. With this option, you can then later switch to an S-corp for taxation purposes. However, the reverse option is not possible. You cannot form an S-corp and then easily convert to an LLC.
If you are a one-owner business, forming an S-corp will not provide significant benefits in relation to profits and taxes. There are circumstances where it may make sense, but if the majority of income comes from the work you put in, there are typically few tax benefits. When compared to an LLC or even a C-corp, an S-corp is not technically a business entity. Businesses form S-corps based on how they wish to be taxed by the IRS.
In comparison, forming an LLC is a popular choice. Although the definition of this business structure differs from state to state, in general terms, an LLC is an entity that is separate from its owners. These owners are referred to as members. In this case, an LLC can have a single member or multiple members. Small business owners tend to form LLCs based on the following:
- Greater flexibility in terms of taxation and management
- Fewer recordkeeping and reporting obligations
If you currently own an LLC, you can likely be taxed as an S-corp. However, there are a few reasons why you may not be eligible, including the following:
- You are operating as a foreign LLC.
- The owner of a single-member LLC is a nonresident.
- The business is structured so that the owner is considered a partnership or corporation.
How Are an LLC and an S-Corp Taxed?
Businesses are taxed on what's known as net profit — or in some cases, there may be a net loss. This is calculated by subtracting all deductible expenses from the total sales. When operating an LLC, taxes are paid on the owner's individual tax returns. For example, if you own 40 percent of a business and the company yields a net profit of $85,000, you will need to claim $34,000 on your tax return.
In comparison, an S-corp will pay out a reasonable salary to owners who actively work within the company. For example, if you were paid $40,000 in salary (with 40-percent ownership of the company) and then the corporation yielded a net profit of $25,000, you would claim a total of $50,000 in taxable income. This value comes from $40,000 in salary + 40 percent of $25,000.
S-Corp vs LLC: Tax Benefits
When it comes to paying taxes, there is no "LLC" tax classification. The IRS classifies all businesses as either a partnership, a sole proprietorship, a C-corporation, or an S-corporation. When an LLC is a single-member entity, the IRS automatically qualifies the LLC as a sole proprietorship for tax purposes. In comparison, multi-member LLCs are classified as partnerships when paying taxes.
When you are a small business, the main difference between being taxed as a sole proprietorship and an S-corp is how owners pay taxes on Medicare and Social Security — or "self-employment taxes." An LLC member reports all business-related profits and expenses on their individual tax return. As of 2016, being self-employed means that each LLC member will pay 12.4 percent Social Security tax (on the first $118,500). They will also pay 2.9 percent Medicare tax on all income.
Depending on your business, choosing S-corp for tax purposes could help you save money.
For example, once you have elected to be taxed as an S-corp, you will be paid a certain salary. For example, say you own 100 percent of the corporation and are paid a $60,000 salary. The corporation itself makes $50,000 in profit. This means that you will report $110,000 of income, but you will only pay Medicare and Social Security taxes on your $60,000 salary.
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