LLC vs S Corp Taxes: Everything You Need to Know
S corps must submit business returns, while LLC need to submit while LLC members need to submit their personal tax ones. 6 min read
2. Internal Requirements:
3. Operating Agreements
4. Tax Advantage of S Corporations
5. Ownership Differences
6. Advantages of Both Entities
7. Disadvantages of LLCs
8. Disadvantages of S Corporations
9. Taxation of LLCs and S Corps
10. Cost of Maintenance
11. Additional Considerations
12. Which One is Right for Me?
LLC vs. S Corp Taxes
When it comes to LLC vs. S corp taxes, you must be aware of the differences. S corps must submit business returns, while LLC members need to submit their personal tax ones. However, LLCs need to file a business return if the organization has multiple owners.
LLCs abide by what is known as pass-through taxation, where losses and profits funnel through business to individual members for them to record on their tax returns. As a result, LLCs are not taxed at any business level. However, both entities are subject to certain formalities in the form of paying fees and submitting annual reports.
Further, LLCs can have as many members as needed, but S corporation are restricted to a 100person shareholder limit. Moreover, non-residents and U.S. citizens can participate in an LLC, but not in an S corporation.
Other similarities include:
- Separation of business and personal liabilities
- Created through state filing
- Pass-through taxation
Overall, S Corporations have more restrictions than LLCs. When pertaining to internal operation, S corporations have to follow certain guidelines. For example, S corporations must:
- Draft bylaws
- Hold annual meetings
- Record the minutes of meetings and keep written records
- Issue stock
However, stock within an LLC can be transferred with ease. For LLCs, membership is non-transferable, and it can be difficult getting approval from members.
Formalities are largely recommended under LLCs. Recommended formalities include:
- Membership Issuance
- Operating Agreements
- Recording Member Gatherings
- Recording Important Decisions of the Company
Moreover, LLCs face certain recommended requirements, such as operating agreements. An operating agreement is a document detailing the internal structure of the business, such as:
- Management Structure
- Roles and Duties
- Payout Structure
Authorities recommend an operating agreement, but it is not mandatory under law. An operating agreement is also a crucial document in case the unexpected happens, such as the death or exit of a member. Such occurrences could cause the LLC to be disbanded. S corporations exist in perpetuity regardless of what happens to members. Under a corporate structure, the entity remains the same, but shareholders and owners can change. Further LLCs have an expiration date, as many states require members to list an expiration date of the business.
S corporations have a superior tax structure because members have a say in how much self-employment taxes they pay. They can simply classify themselves as an employee and take a salary to avoid self-employment taxation. Further, corporate earnings after salary payment could be regarded as unearned income that remains above self-employment taxation.
LLC owners have enough leeway in choosing members or managers to manage daily affairs of the business. LLCs closely resemble partnerships in terms of management structure. LLCs operated by manager align closer with corporations because members would not be entwined in everyday business operations. With S corporations, there are officers and directors:
- Officers: Officers take the form of CEOs, CFOs, etc. They are responsible for carrying out the directives of the directors.
- Directors: Directors comprise of a board that elects officers to operate the daily operations of the company. Moreover, they make major decisions that impact the company but do not engage in daily operations.
Advantages of Both Entities
Both entities allow deductions measures that lower tax expenditure, such as:
- Phone Bills
- Advertising and Promotion
- Car Costs
- Health Care Costs
All of the aforementioned factors can be written off as business expenses on your tax return.
Benefits of an LLC over an S Corp.
- Less expensive, usually costing around $200
- Less Restrictions
- Less red tape and additional savings on attorney and accounting fees.
Disadvantages of LLCs
With that, sole LLC owners are required to pay self-employment taxes in the same manner as a sole proprietor. A sole proprietorship is a separate entity whereby a single owner conducts business. In addition, single-member LLCs need to issue payments to the IRS on a quarterly basis. Further, LLC owners must be avoid penetrating the “corporate veil, which is breaking the barrier between personal and business expenses. Breaking barrier could open yourself up to litigation from creditors who could lawfully seize your assets.
Under S corporations, any excess profit can be classified as distribution, which could be reclassified as profit and distributed accordingly. Dividends are taxed at a lower rate than personal income. Additionally, an S corporation can pay employees what is considered a “reasonable salary,” which would lower self-employment tax and deduct payroll expenses.
Disadvantages of S Corporations
S corporations cannot have over 25 percent of gross receipts stemming from passive operations in the form of real estate investing. Also, shareholders should be aware of what is considered a reasonable salary to avoid potential audits. The IRS scrutinizes the returns of S corporation more than other entities due to the possibility of fraud and abuse.
Taxation of LLCs and S Corps
Each business is taxed based on net loss or profit, which is then calculated by taking sales minus deductible expense. For instance, a 50-percent owner of an LLC having a net profit of $120,000 forces you to declare 50 percent of the net profit on your personal return, boiling down to $60,000 on your personal return. S corporations pay more in taxes because of state corporate and payroll taxes. All salaries paid to owner of an S have unemployment and disability taxes to pay. Individual owners, on the other hand, do not pay disability or state unemployment taxes. Because of that, LLC owners are not entitled to disability or state unemployment benefits.
Cost of Maintenance
States may impose a corporate tax rate that are more expensive than LLC fees. However, corporate taxes vary by state, and you should contact a local CPA to find out more information. Many new businesses are classified as freelance consultants in the form of independent contractors, working for a single client. However, individuals can reclassify into an S corporation. The IRS allows this because of the relationship is more like a corporate entity that is paying disability and unemployment taxes. With that, a lawyer should always be consulted before such a strategy is implemented.
Experts advise you to start out as an LLC, especially smaller entrepreneurs. Moreover, tax law gives you leeway to switch into a cooperation in the future, but you cannot revert to an LLC if you are a corporation.
For small businesses, the main contrast is where Social Security and Medicare taxes are concerned. Self-employment taxes fund these programs, and LLC members are obligated to pay their share stemming from profits. LLCs need to report salaries as business expenses, which allows the owner to report the income on personal tax returns. S corporations only pay these taxes when the owner’s salary is taxed.
Which One is Right for Me?
To find out which entity is the best for you, you must first decide what a reasonable salary would for a personal in your position. You can conduct research online to determine a reasonable salary for yourself. This is an area where the IRS scrutinizes the most, so you must set a salary that will not raise suspicion. If business profits are more than the reasonable salary, then choose the S corp. route to save additional money.
Moreover, the entity you choose largely depends on the nature of your business and how you envision your business in the future. For owners who wish to get the best personal protections while planning to expand into a publicly traded company should go the corporate route. If you register as a corporation, you will start as a C corporation, and you will then have to reclassify into S status. Many S corporations start as separate business entities such as a C corporation or sole proprietorship.
However, larger operations should be classified as an S corporation immediately if appropriate.
Note: C corporations cannot be operated by another corporation, including LLCs, partnerships and sole proprietorships. LLCs, however, can be owned by entities.
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