Online Business Incorporation: LLC or S Corporation?
Determining whether an S-corporation or LLC is right for your business
When deciding to incorporate, many entrepreneurs wonder which is better, LLC or S corporation. When you’re weighing an S corporation versus an LLC, there are a number of factors you need to consider. Having a tax lawyer or accountant examine your situation and help you determine your needs is always advised.
S Corporations and LLCs: Similarities
S corpations and LLCs are similar in that they are both "pass-through" entities for tax purposes, meaning that the income derived by both S corporations and LLCs is passed through directly to the owners and reported on the owners' personal income tax returns. This is what is known as avoiding double taxation (With a C corporation, the corporation’s net income is subject to corporate income tax, and what remains after the corporate income tax is taxed a second time when it is paid out to the owners).
LLC or S Corporation : Which Is better?
Obviously, the answer to that questions depends on your particular situation and should be discussed with a tax professional. So what is the difference between an S corporation and an LLC? And which type of entity is right for you?
LLC’s require less formality and paperwork and are more flexible in how owners divide up profits. But, S corporations allow owners to save on employment taxes.
LLC or S Corporation : Ownership Restrictions
S corporations can only have 100 shareholders. None of the shareholders can be nonresident aliens, nor can they be other corporations or LLCs. S corporations must also follow corporate procedures and have no flexibility in dividing profits among owners (e.g. if John owns 29% of XYZ, Inc., he is only able to make 29% of the profits).
There are no restrictions on the ownership of an LLC. Additionally, an LLCs is more simple to operate because it is not subject to the formalities by which S corporations must abide.
LLC or S Corporation : Division of Profits
One big difference between S corporations and LLCs is that owners of an LLC can distribute profits in the manner they see fit. For example, assume Adam and Bart own an LLC to which Adam contributed $80,000 in capital and Bart only contributed $20,000. If Bart performs 80% of work the owners could still decide to split the profits 50/50. If these same partners owned an S Corporation, Adam would be required to take 80% of the profit and Bart only 20%.
Employment Tax: Savings by Forming An S Corporation
Owners of an LLC are considered to be self-employed and therefore must pay a "self-employment tax" of 15.3% (goes toward social security and Medicare). The entire net income of the LLC’s business is subject to self-employment tax.
For S corporations, only the salary paid to the owner-employee is subject to employment tax. The remaining income that is paid as a distribution is not subject to employment tax under IRS rules. Therefore, an owner of an S corporation stands to realize substantial employment tax savings.
LLC or S Corporation - Examples:
S Corporation Scenario
Adam owns an ecommerce company that has $60,000 in earnings per year. He pays himself reasonable compensation of $35,000 to run the business. He takes the remaining $25,000 as a distribution. Adam’s total employment tax is $5,355 (15.3% of $35,000).
In the above scenario, you cannot manipulate your salary to make it artificially low in order to pay less employment tax. If the salary isn’t a reasonable one for your industry and job type, the IRS could reclassify some of the distributions as salary.
LLC Scenario
Assume everything in the above example is the same, except that Adam’s entity is an LLC and not an S corporation. As an LLC, Adam would have to pay employment tax on the entire $60,000, equaling $9,180.
In the two scenarios above, Adam saves $3,825 in employment tax as an S corporation.
The employment tax savings makes the S corporation attractive. But, you still have to deal with paying payroll taxes. The payroll tax is a pay-as-you-go tax that must be paid to the IRS regularly throughout the year--on time, or you will incur interest and penalties. When you incorporate with Click&Inc, you get a free month of payroll processing from ADP and a waiver of all set up fees. The few bucks a day this service will cost you is more than made up by having payroll taxes handled for you.
Unlike S corporations that pay as they go, owners of LLCs pay their self-employment tax once a year on April 15 when they would pay their personal income tax. A single-member LLC files the same 1040 tax return and Schedule C as a sole proprietor; partners in an LLC file the same 1065 partnership tax return as do owners of traditional partnerships.
FORM A CORPORATION OR LLC FAST & EASY
