LLC vs S Corp Tax: Everything You Need to Know
The differences in LLC vs. S-corp tax mainly involve how much money is paid in self-employment taxes. 3 min read
The differences in LLC vs. S-corp tax mainly involve how much money is paid in self-employment taxes. S-corp is not an actual business structure; it's simply a tax designation that an LLC may choose. Knowing the advantages and disadvantages of an LLC vs. an S-corp can help you make the right decision when forming your business.
Tax Differences Between S-Corps and LLCs
People who want to run a business that offers the benefits of pass-through taxation and liability protection often choose to form LLCs (limited liability companies) or S-corporations.
LLCs offer protection for an owner's personal assets from the following:
- Company debts
- Company losses
- Court rulings against the business
An S-corporation structure also offers personal asset protection from corporate liability. It passes through income as well, typically in the form of dividends, so there's no double taxation (on the personal and corporate level). In this way, S-corps and LLCs are similar. However, there are important differences between the two that you should carefully consider when deciding which type of business you want to form.
The IRS categorizes businesses as one of the following types, for tax purposes:
- Sole proprietorships
There's no classification for LLCs, so LLCs are treated as another type of business. The IRS taxes single-member LLCs as sole proprietorships, and it taxes multimember LLCs as partnerships. You can opt to have your LLC taxed as a C-corp or S-corp.
How Much in Taxes Will You Pay?
For most small-business owners, the biggest difference is in how Medicare and Social Security taxes (or self-employment taxes) are treated. By choosing the S-corp designation, you may be able to save money on taxes.
LLC members report their business income and expenses on their personal tax returns. They pay taxes on the company profits. Because members are treated as self-employed individuals, they're responsible for self-employment taxes on those profits.
Effective as of 2016, a self-employed person pays a Social Security tax of 12.4 percent on the first $118,500 of income, along with a 2.9 percent Medicare tax. High earners pay an added 0.9 percent in Medicare tax. Employees pay these taxes too, but their employer pays half, so employees only pay the other half.
More on S-Corps
A member can be considered an employee of the company in an S-corp. If you're an owner-employee, you should receive a reasonable salary. The salary is reported as a business expense, and the owner reports the salary, as well as any remaining business profits on a personal tax return. Compared to an LLC's sole proprietor who's responsible for Social Security and Medicare taxes on all profits, an S-corp's owner pays these taxes only on the owner's salary and not any remaining profits.
The IRS clearly spells out who can quality as an S-corp, so not every business can choose this tax designation. The majority of single-member LLCs are eligible, but the following can't choose the S-corp classification:
- Foreign LLCs
- LLCs with an owner who's a nonresident alien
- An ownership structure that's a partnership or corporation
- Multimember LLCs with more than 100 members
Before choosing to operate as an S-corp, consider if you'll actually save money under that classification as well as what is a reasonable salary for your defined job. If company profits are higher than a reasonable salary, you may save money as an S-corp.
You can change your company's tax status if you have already started your LLC but aren't happy with the tax consequences. If you want to make the switch, you can choose the S-corp status any time during the tax year, prior to the year you want your changes to take effect. You can also make the change within the first 75 days of the current year.
While tax benefits are always appealing, not everyone is able to operate as an S-corp or even needs to. If you're not happy with your current designation, however, you may be able to change it for the future.
If you need help with deciding between an LLC and S-corp, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.