LLC vs. S corp Tax Benefits

LLC vs. S corp tax benefits vary depending on your company. In an LLC, members of the company report earnings on their individual taxes. In an S corp, taxes are paid through the business only.

What Is an LLC?

A Limited Liability Company or LLC receives its permission to do business according to state law. An LLC, like a corporation, has limited liability, but it is not as complicated to set up and run as a corporation. Although states define LLC differently, an LLC is a business that is distinct from the owners who are called “members.”

There can be a single member in an LLC or a large number of members. This type of structure is appealing to small business owners, because there are many ways to manage an LLC, and there is not as much paperwork and little requirement to provide information, such as records.

What Is an S Corporation?

An S corporation is not an actual corporate entity, like an LLC or a C corporation. A company is given the S corporation designation because of the way in which it is taxed by the IRS.

Business Structure

When starting a business, it is important to find the right structure. The type of structure you choose can affect the amount of liability you may have and your tax rate. In addition, the structure of the business can have an impact on the way your company grows, attracting investors such as shareholder and the operations of the company.

There are a number of requirements from the federal government regarding business structure. These requirements can also differ depending on what state you reside, so that is why it is essential to get the advice of a business lawyer or a qualified accountant concerning these issues.

How are an LLC and an S Corp Taxed?

The IRS uses various categories of businesses to determine how they are going to be taxed. These categories include:

An LLC does not have its own category and are taxed as a kind of business. LLC that have only one member are taxed as sole proprietorships, and those with many members are in the category of partnerships.

An LLC owner files something called an election with the IRS in which it determines whether it is going to be in the C corporation or S corporation tax category. After the election is on file, the LLC is treated as if it is like either type of these corporations.

The IRS taxes businesses according to their net profits or losses. This number is found by computing the amount created by sales minus deductible expenses.

The member of the LLC reports all income and expenses related to the business on his or her own income taxes. This means the member has the responsibility of paying taxes for company profits and as well as Social Security and Medicare, because a member is considered as self-employed.

According to data in 2016, someone who is self-employed and making $118,000 owes 12.4 percent Social Security tax and a 2.9 percent Medicare tax. Those earning large amounts of money owe an additional 0.9 percent in Medicare tax. In a traditional situation, the employee and employer share the burden of these taxes.

What this means for a member in an LLC is that if your own 50 percent of the business that makes a profit of $60,000, you will pay taxes on half of that amount on your personal income taxes.  

If you have an S corporation, as the owner you are given a good salary. Once this salary is deducted as a business expense, any profits or losses from the business are part of your personal income tax return.

If you own 50 percent of a business, earn a $60,000 salary, and if there is a $30,000 profit, on your income tax return, you will be responsible for taxes for the $60,000 salary and half of the profit, namely an additional $15,000 for a total of $75,000.

For an LLC, you need to pay Social Security and Medicare taxes on all of the profits as well as the income. In an S Corporation, these taxes apply only to the salary itself.

An S corporation functions like a partnership in that the income “passes through” from the business finances to the member’s personal income taxes. In addition, an S corporation is required to file a 1120S form that reports financial, and includes data concerning:

  • Deductions
  • Profits
  • Losses
  • Tax credits

Companies file these forms annually as required by the tax authorities.

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