The Difference Between An S Corp And A C Corp
LLC members can also choose to have their LLC taxed as a C corp. The legal status of the company wont be changed to a corporation, but you can choose to have it taxed as one for various reasons.
If LLC members choose this option, they have to pay corporate taxes on their earnings at the current flat rate of 21%. All remaining profits are distributed among the members from the after-tax funds.
S Corp vs C corp tax advantages are evident in the fact that S corps dont have to pay federal taxes on the majority of their earnings, and they can freely distribute company gains among shareholders. If S corps want to use these tax advantages to their benefit, though, they have to comply with strict regulations imposed by the IRS no more than 100 shareholders, domestically based, no individual investors, and offer only one class of stock.
C corporations dont have to comply with these rules and they can expand their base of operations, meaning they are usually larger than S Corps.
Should My Llc Be An S Corp
If your LLC is growing in profitability or you expect it to soon, you should consider S corp. classification. This allows profits to pass through the corporation into your wallet without incurring a hefty self-employment tax on all net earnings.
Both LLCs and S corporations offer personal liability protection that shields your personal assets. When starting a business, it’s important to think ahead and envision what kind of growth you want to achieve. Your goals and aspirations could determine which business entity and tax classifications are right for you.
Choosing A California Llc Or S Corp
Whether your business should be operating as an LLC or as an S Corp in California should be carefully evaluated. The tax implications to the business and its owners, the nature of the business, and its future plans and goals should all be taken into consideration.
An LLC will be less expensive and simpler to set up. It will also be easier to maintain and to keep in compliance with the law. On the other hand, S Corps are more logical in some cases. Being an S Corp is ideal if your business plans to go public someday or may seek substantial external financing. Although changing the structure of your business is possible, such conversion may incur additional tax liabilities to the owners.
There is no need to navigate through the complexities and challenges of establishing a business alone. Figuring out which option is best for your company can be difficult. Windes is here to help with professional advice before you make your final decision.
For more information about this article, please contact our marketing department at or toll-free at 844.4.WINDES .
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The Advantages Of An Llc Filing As An S Corp For Tax Purposes
There are many decisions you have to make when starting a business. One of them is choosing a business structure.
An LLC is a popular option. LLCs offer business owners a range of advantages, including reduced personal liability and paperwork.
However, many business owners dont realize they can file as an LLC, while opting for the IRS to treat the business as an S corporation when its time to do taxes.
There are several reasons to consider LLC filing as an S corp. To better understand why you may want to go this route, keep the following essential points in mind.
What Are Llcs And S Corps
An LLC is a type of business entity while an S Corp is merely a tax designation.
The actual definition of an LLC depends on the state in which it is formed. LLCs are basically business entities that protect their owners or members from liabilities and can choose how they would like to be taxed as a corporation or a disregarded entity.
LLCs may have one or several members and so be called either a single-member LLC or multi-member LLC.
This type of business entity is very popular with small business owners and entrepreneurs because it allows for a lot of freedom in the structure of the company as well as providing legal protection and low financial risk. Corporations tend to require more reporting and have more regulations when it comes to management and organizational decisions for the company.
An S Corp is a specific tax designation recognized by the Internal Revenue Service and Internal Revenue Code , so an LLC can actually also be an S Corp if it files a Form 2553 to elect that specific status.
- C Corporations
- S Corporations
LLCs are not actually a type of business structure in the eyes of the IRS, but they must elect a particular designation.
Single-member LLCs are taxed as sole proprietorships while multi-member LLCs are taxed as partnerships unless they request otherwise.
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Filing In California For An Llc
To form an LLC in California, you will need to register with the Secretary of State. The Secretary of States office defines the fees and rules. Below are seven steps to follow to complete the process.
The name of any business cannot be so similar to another companys name that it confuses or misleads customers. It is possible to search business names that are currently on file with the Secretary of State at www.sos.ca.gov. Every LLC in the state is required to have a business name ending in LLC or Limited Liability Company. A business can abbreviate limited to Ltd. It can also condense Company to Co. In addition, the name may not contain the words Bank, Incorporated, Trustee, Inc., Corp, Corporation, Insurance Company, or Insurer.
The law requires each LLC in California to have its own registered agent. Registered agents are companies or individuals that accept official and legal documents on behalf of the business. If you are filing in California, that agent is required to be a resident of California. The agent must also have a physical address within the state.
All California businesses require a business license. The most basic form of license is the business tax certificate or general business license. Counties and cities are responsible for issuing those licenses. Therefore, if your business operates in several locations, it will need several licenses.
Combining The Llc And S Corporation
Small business owners can choose to set up their business as an LLC and then opt to file taxes as an S Corporation. Legally, your company is an LLC. To the IRS, however, your business is an S Corporation. This combination gives you the advantages of less state filings, less paperwork, and lower costs overall. You also get the benefit of being able to distribute some of your profit as non-taxable distributions, rather than as salary or wages. Prior to electing for an S corporation status, it is necessary to obtain an EIN .
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Choosing A Business Entity
S corporation tax benefits are the financial benefits you will gain by being taxed as an S corporation. Such benefits are often the main reason why business owners elect to have their business considered as an S corporation by the IRS, although there may be other reasons as well. Some may assume that running an S corporation will be too time-consuming or costly, but if done correctly, this is usually not the case, and the benefits of pass-through taxation the main tax benefit of S corporations can often make it worth it.
That said, there are many factors to consider when deciding if an S corporation is right for you. Structure, asset distribution, liability protection, and ease of ownership transfer are just some of these factors. Due to the importance that the choice of business structure bears on ones business, all factors should be considered before a decision is made. C corporations, LLCs, sole proprietorships, and partnerships are also options, and the best structure depends on the plans you have for your business, what kind of business you are running, and what your goals are, both in the short term and long term.
Llc Electing S Corp Tax Status: An Option You May Not Know You Have
If you think you can benefit from the combined features of using an LLC to own and operate your small business and then having it be taxed like an S corporation, the possibility exists to establish your business as an LLC, but then make the election to have it treated as an S corporation by the IRS for tax purposes.
If you decide to form an LLC to own and operate your small business, you have a couple of choices for how you want your LLC to be taxed. For federal income tax purposes, there is no such thing as being taxed as an LLC. Instead, an LLC can be taxed like a sole proprietorship, a partnership, a C corporation orif it qualifiesan S corporation.
Although being taxed like an S corporation is probably chosen the least often by small business owners, it is an option. For some LLCs and their owners, this can actually provide a tax savings, particularly if the LLC operates an active trade or business and the payroll taxes on the owner or owners is high.
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The Best Of Both Worlds: Having Your Llc Be Taxed As An S Corp
If youre still feeling indecisive, this might help: You can elect to have your LLC taxed as an S corporation. This was the approach I personally used in my business I wanted the simplicity of an LLC, but the tax savings that come with an S corp classification.
Roberts agrees. Setting up as an LLC then electing to be taxed as an S corp can sometimes be the best of both worlds. It combines the ease of owning a flexible creature of contract an LLC with the tax savings of a corporation. When done right, the savings can be huge, particularly when it comes to self-employment tax.
Wheeler notes that this election depends on your numbers and your profitability.
Ultimately, it comes down to whether you have sufficient profits to pay yourself reasonable compensation plus some, she says. Otherwise, you wont get to take advantage of the S Corp tax benefits. Whats reasonable compensation depends on your industry, the work you do, how experienced you are, etc. and you also need to consider the state youre located in. California, for example, taxes S Corps at a higher rate than LLCs. Bottom line make sure youre working with a tax advisor who understands S corps and start the conversation early.
If you choose this option, be prepared for some extra paperwork.
Dont forget to consider the additional administrative burden the S Corp election means taking extra steps and the tax savings may not be worth the extra burden in every case.
Llc Owners Electing S
Most limited liability company operating agreements contain language drafted for partnership accounting, including language that talks about substantive or alternative economic effect. These provisions are inapplicable to an LLC taxed as an S-corporation. In fact, they can be worse than inapplicable, they can be problematic, causing the S-corporation election to fail. The reason is based on Treasury Regulation §301.7701-3, which states the election is only valid if the entity meets all other requirements to qualify as a small business corporation under section 1361. One of the requirements of 1361 is that the company has only one class of stock. Any varying rights among stockholders may be deemed to constitute multiple classes of stock. Because some of the partnership accounting provisions in a typical operating agreement can lead to disparate treatment among similarly-situated members, the IRS can argue there are multiple classes of equity. This is a confusing topic. If you want to dive deeper into it, visit Partnership Provisions in LLC Operating Agreement Renders S Election Invalid.
The repercussions of a failed S-corporation election can be major, including reclassification of your income and the assessment of retroactive taxes. Fortunately, the issue is easily handled by talking to your business lawyer and asking them to review your operating agreement and make any necessary changes at the time you elect to be taxed as an S-corporation.
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Tax Treatment Of Llc Income
When an LLC opts for an S corporation tax structure, it typically changes the way the IRS treats that LLCs income.
When income from LLCs passes through to owners, they pay tax on it as self-employment income. The self-employment tax comes to 15.3%, with Social Security representing 12.4% and Medicare tax representing 2.9%.
As anyone whos checked their pay stub knows, self-employment taxes are higher than Social Security and Medicare taxes paid by workers who arent self-employed. As a result, in 2022 employees withhold just 6.2% for Social Security and 1.45% for Medicare. Thats because employers pay another 6.2% for Social Security and 1.45% for Medicare without passing it onto employees. Self-employed people pay both halves.
There are two more key factors to consider here:
- Income from a corporation is treated as a dividend rather than earnings. That means dividend recipients dont have to pay Social Security and Medicare taxes on that income.
- The owner of an S corporation can let some of their business profits pass through as earnings. Meanwhile, other profits pay out as dividends that are free of self-employment tax.
By having LLC treated as an S Corp for tax purposes, a business owner may save a considerable amount in tax payments.
Filing In California For An S Corp
There are 10 steps to filing a business as an S Corp in the state of California.
No corporation can have a name similar to, or the same as an existing name held on file. Although the state does not require it, it may include the word Limited, Incorporated, or Corporation in its name, and the name cannot mislead the public.
S Corps have a legal responsibility to file Articles of Incorporation General Stock . Businesses must file this with Californias Secretary of State. In the Articles, a business must include:
- the name of the corporation
- the address of the corporation
- the address and name of the S Corps registered agent and
- the number of shares that the corporation can issue.
All S Corps need to choose a registered agent. This agent will accept all legal documents on behalf of the corporation. The state requires that the agent resides in the state and has a physical California address. The agent must also file a Registered Corporate Agent for Service of Process Certificate on Form 1505.
It is essential to create a book of central records containing corporate documents. The corporate documents that are required to be maintained permanently include minutes from shareholder and director meetings, stock certificate stubs, and stock certificates.
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Llc Or S Corp: Why Decide Now
There are three main reasons to consider incorporation sooner rather than later.
Youll Save Money a Lot of Money. The Internal Revenue Service makes business ownership an attractive option. When youre incorporated, there are ample opportunities to write off expenses and investments you make in the business, which reduces your overall taxable income. You wont get these same benefits when youre self-funding with no paper trail.
Youll Get Protections. If you incorporate as a business entity, and your business is sued or finds itself in debt later on down the line, your business will be liable. Your personal assets, however, will be not liable if your business goes under, youll keep the house, car, and savings account.
We dont start a business expecting to go bankrupt, but the reality is that it happens: 50% of businesses fail within the first five years. The pandemic also showed us that tides can turn unexpectedly in commerce its possible that forces outside your control could lead to reduction or termination of your business.
You Might Be More Motivated. When you incorporate your business, youre going to take it more seriously, and your prospective clients will too. Business owners who expect to be around for the long game take the time to incorporate because it projects professionalism and quality to customers. Youve already come this far do yourself a favor and officially form your business to give yourself peace of mind.
How To Form An S Corporation
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