Ability To Leave Money In The Company
While C corporations are subject to double taxation, they offer more flexibility in terms of income shifting compared with pass-through entities like LLCs and S corporations. When an LLC is taxed as a pass-through entity, its members must pay taxes on their share of the profits, whether or not that money stays in the business or is distributed to their personal account.
Tax Flexibility Of An Llc
The Internal Revenue Service does not view an LLC as a separate vehicle for tax purposes, which allows for greater flexibility. Members can choose how they are taxed. They can be treated as a sole proprietorship, a partnership, or a corporation. The most common tax option of an LLC is taxation similar to a sole proprietorship. A member has to pay taxes themselves on the profits of the LLC as opposed to the LLC paying the taxes. The profits and losses of an LLC are passed through the business to the owner. The owner then has to report the profits or losses on their own personal tax returns. The LLC itself does not pay any corporate tax. This method avoids double taxation, which is a drawback of corporations.
Do S Corps Pay More Taxes Than Llcs
Actually, no. In most cases, the taxes on S Corps are lower than on LLCs. As an LLC, you can be subjected to hefty self-employment taxes of 15.3% on all net earnings from your business. An S Corp tax status allows you to withdraw a salary and only pay taxes on that salary.
For example: If your LLC’s income is $65,000, you’d be obligated to pay a 15.3% self-employment tax. This amounts to $9,945. In contrast, if your S Corp has the same earnings and you have withdrawn a salary of $42,000, your employment tax amount would be $6,426, saving you $3,519.
It’s important to note that LLCs have itemized tax deductions that can lower the amount you owe to the IRS.
Which Business Entity Is Right For Me
Is it better to be a single-member LLC or an S Corp? Determining which structure is right for you comes down to what your business really needs. You must ask some hard questions to identify the right fit for you.
As S Corp status could work well for you if you have robust plans for scaling and if your business is already making decent profit margins. If you have achieved a consistent level of growth where you can draw out reasonable salaries for yourself and other owners, then the tax break could be ideal for you.
An LLC works well in cases where you are concerned about prioritizing the protection of personal assets but don’t want to be involved in a lot of upkeep and compliance measures. LLC reporting requirements are typically much simpler most LLCs are just required to file an annual report.
Using the services of a financial advisor can also help you make an informed decision as to which entity is best for you and whether the tax benefit of an S Corp is worth the additional paperwork.
What Is Limited Liability
Limited liability is a type of protection for your personal assets. It ensures that your personal liability for the business’ debts and obligations is no more than the amount of money you invested in the business. This protects your home, automobiles, and other personal assets from being used to pay off any debts accrued by your business.
Without limited liability protection, your home could be used as collateral to repay the businesses debt after a lawsuit or bankruptcy. This is, by far, one of the greatest advantages gained by forming a business entity.
Now that we have explored what both entity types have in common, let’s dive deeper into what makes them different.
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What Is The Difference Between A Legal Entity And A Tax Entity
Many new business owners get confused when it comes to understanding the difference between legal entities and tax entities. Let’s take a moment to unpack their differences.
A tax entity is how the IRS sees your business. Subsequently, this reflects how your business will be taxed. Tax entity examples include C Corporations, S Corporations, and sole proprietorships. Legal entities have a choice about what tax entity they want to identify as. Both an LLC and a corporation can file an S Corp election and choose to be taxed as an S Corporation, even though they are still two different legal entities.
Overall, LLCs have more options when it comes to choosing a tax identity than corporations. However, both legal and tax entities offer benefits that are best consulted with a CPA or attorney that understands the ins and outs of your business.
Starting Your Llc Vs S Corp Journey
Many entrepreneurs set up their new ventures as LLCs to have some legal protection for their personal assets. However, when your business grows, its a good idea to speak with your CPA and look into filing as an S corp for the financial benefits. To follow the proper guidelines under your states laws, you should also determine how many investors, stock classes and foreign owners will be members of your LLC.
Max Freedman and Joshua Stowers contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.
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Who Should Consider Opening An Llc
The LLC is a good alternative for non-resident business owners who like flexible management since C Corporations have a more traditional structure in which the directors are the only decision-makers. Comparing a Corporation vs. LLC, their structure is so rigid that it requires annual and documented meetings of directors and shareholders. LLCs are much more elastic in this sense.
An LLC is also a good option for those who wish to receive earnings every fiscal year. Alternatively, in the case of a company with partners, they will have to share this value according to each partners participation in the business.
The Disadvantages Of An S Corp
The upside of an S Corp election is usually reduced corporate taxes. The drawback? Compared with continuing to work for yourself as a sole proprietor, it can be more complex. After organizing your business as an LLC, you must file the forms with the IRS.
Taxes also get more complex, because you have to pay yourself a regular paycheck and deduct payroll taxes throughout the year. Youre also required to pay quarterly estimated taxes for the business. At tax time, though, you still only have to file a personal income tax return.
Most, but not all, states recognize S Corp tax status. If youre in a state that doesnt, youll file taxes differently for federal and state, and that could get complicated.Youll probably want to enlist the help of a lawyer and accountant once your business is ready for this structure. Or sign up with Collective, and well handle all the details for you.
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Llc Vs Corporation Ownership
Corporations issue shares of stock to their owners, who are called shareholders. Corporate shares are easy to transfer from one owner to another, and therefore a corporation can be a good choice for a business that anticipates having outside investors or making a public stock offering.
The owners of an LLC are called “members,” and instead of shares, each member owns a designated percentage of the company, sometimes called a “membership interest.”
Membership in an LLC may be more difficult to transfer than shares in a corporation. An LLC’s operating agreement will typically specify whether and how membership interests can be transferred.
In some states, if a member leaves an LLC and the operating agreement does not specify otherwise, the LLC must be dissolved.
Differences Between Llcs And Corporations
Both these business types will require you to file business formation documents with the state. Both protect company owners from personal liability for business obligations. In general, corporations have a more standardized and rigid operating structure and more reporting and recordkeeping requirements than LLCs. LLC owners have greater flexibility in how they run their business.
Taxwise, LLCs have more options than corporations. LLCs arenât tied to one particular tax classification and can be taxed as sole proprietorships, partnerships, C corporations or S corporations.
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Llc Vs Corporation: Formal Requirements
Both corporations and LLCs are required to fulfill maintenance and/or reporting requirements set by the state where their entity has been formed. This keeps the business in good standing and maintains the limited liability protection acquired by incorporation. While every state has its own rules and regulations that govern both corporations and LLCs, corporations generally have more annual requirements than LLCs.
Corporations are required to hold an annual shareholder meeting each year. These details are documented, along with any discussions, as notes called corporate minutes. A corporation is generally required to file an annual report, too. This helps keep the business’ information current with the Secretary of State. Any actions or changes in the business will require a corporate resolution to be voted on at a meeting with the board of directors.
LLCs, on the other hand, have fewer record keeping requirements than their corporation counterparts. For example, an LLC is not required to keep minutes, hold annual meetings, or have a board of directors. While some states still require LLCs to file annual reports, others do not. Check in with your local Secretary of State to determine which requirements are applicable to your LLC entity.
Allows Stock To Be Issued
LLCs have a harder time raising capital for the growth of a business because, unlike with corporations, the owners cant issue shares of stock to attract investors. Many investors are more likely to be attracted to investing in the more familiar form of corporations. Having a corporation will also allow you to do an IPO, which is not possible with an LLC.
Stocks also make the process of buying and selling parts of the business much easier. Transferring ownership of an LLC is usually a much more complicated process.
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Tips To Maximize Your Business Potential
- Enlist the help of a professional if you need help managing the finances of your small business. Finding a qualified financial advisor doesnt have to be hard. SmartAssets free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If youre ready to find an advisor who can help you achieve your financial goals, get started now.
- Where you bank with your business is often overlooked, but paying attention to this detail can boost your finances significantly. Check out our list of the best banks for small business to take advantage of these opportunities.
Tax Differences: What Are The Taxes Involved For All Entities
1. Pass-through Taxation
The first thing you need to understand about entity taxation is pass-through taxation.
Sole proprietors, partnerships, LLCs, and S-Corporations are taxed as pass-through entities.
This means that all income your business receives passes through to you personally.
For example, if your business made $100,000 and you owned 100% of that business, then you would be required to pay taxes on that $100,000 individually.
The exact tax you pay on that will depend on the tax bracket your total personal income falls in.
2. Double Taxation
Only C-Corporations are subject to double taxation.
Double taxation is where the company itself is taxed on all of its profits, before payments to owners are made.
And then the owners are taxed on payments they receive from the corporation.
So, youre taxed twice.
Because of double taxation, C-Corporations are not a popular choice amongst small businesses.
But lets discuss a major tax that most small businesses encounter as pass-through entities.
3. Self-Employment Tax
Self-employment tax is an extra 15.3% tax on your income.
Its the governments way of funding programs like Social Security and Medicare, which is normally deducted from your paycheck as an employee.
The only difference is, as a business owner, youre paying both the employer and employee portion of the tax, equaling a total tax of 15.3%.
Now heres the thing about self-employment tax, it does not apply to S-Corporations or C-Corporations.
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Social Security And Medicare Taxes
LLC members are not considered employees, so their share of the profit is not subject to social security or Medicare tax. However, LLC members who actively work in the business need to pay self-employment taxes on their income . However, with a corporation, only the salaries are subject to social security and Medicare taxes. Any profit distribution isnt subject to these taxes.
Keep in mind that an LLC can opt to be taxed as a corporation. In this case, only the members salary is subject to social security and Medicare and not the profit distribution.
Llc Vs Corporation: How They Are Formed
You form a corporation or LLC by filing a certificate of formation with the Texas Secretary of State. The certificate contains the basic information about your business entity, including its legal name and the name and address of a registered agent, a person or business within the State of Texas that is authorized to receive legal papers on the entitys behalf. You can serve as your own registered agent provided you actually live in Texas.
Sole Proprietor Vs Llc Vs S
The best entity for you will ultimately depend on where you are in your business.
But heres some very general recommendations.
When youre just getting started, start off as an LLC.
Its super easy to set up and it will provide limited liability for your business.
Once you start making over $50,000 per year in business income, then consider electing S-Corporation status.
This will limit your exposure to self-employment taxes as you continue to grow your business.
Contact our tax consultants today for more detailed tax advice for your specific tax needs.
Llc Vs Corporation: Legal Identity And Liability
Corporations and LLCs are both considered legal persons with identities separate from any of the individual owners. Most importantly, this means that the corporation or LLC can sue and be sued in its own name. This generally protects the owners from personal liability for any business-related debts. The owners liability is limited to their interest in the business itself.
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Dues Can Be Deducted Too
Any dues that a taxable LLC or corporation pays in order to be a member of a professional organization can be deducted. Additionally, any magazine or newspaper subscriptions an employee or executive has that are relevant to the business can be deducted. These costs are not a part of employee income.
Management: Offers Flexible Management Structure
Corporations have a strict structure requiring a board of directors who deal with managerial responsibilities and corporate officers who handle daily operations. Its still legal in all states to have a one-person corporation, someone who wears all of those hats, but the corporation still has more government-established guidelines it must follow.
An LLC is much more flexible in how its managed. Any single member or group of members can manage it, making for a more centralized management structure. In cases like this, the member-managers are heavily involved in running the business. However, if the members are primarily investors, they might opt to hire a manager to handle day-to-day operations, or appoint one or more members to fulfill that role.
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Why Would You Choose An S Corporation
If youve been working for yourself for a while, youve probably felt the burn of the self-employment tax. Its a surprise to a lot of new business owners, and its why taxes feel like such a burden when youre a Business-of-One versus an employee.
Electing S Corp taxation could help you cut the cost of self-employment tax significantly if your business income is a lot higher than a reasonable salary for your work.
Technically, your taxation is split among the business and your personal payroll and income taxes, but in effect youre still paying the self-employment tax but only on the salary portion of your income, instead of all of the profits you earn from the business.
What Do Llc And Inc Have In Common
In the above section we answered the question whats the difference between LLC and Inc.. Now, lets quickly look at what they have in common.
The main commonality is that both corporations and LLCs limit the personal liability of the owners/shareholders from the debts of the business and against lawsuits against the business.
But while both structures start protecting business owners from day one, both business types must work to keep their operations separate from the activity of the owners to maintain their personal liability protection.
This is known as the corporate veil, meaning that there is a separation between the liability of the business and the liability of the owners. If a court finds that the operations are not separate, the owners or shareholders can be personally liable for the actions or debts of the business. On a side note, there are some states where piercing the corporate veil is a lot more difficult, making them popular destinations for LLCs and corporations. Delaware and Nevada are two such states.
Some people think that an LLC offers less protection against liability, but thats simply not true.
Here are some other similarities:
Pass-through taxation. Both LLCs and corporations can be pass-through tax entities, meaning no income taxes are paid at the business level. Business profit or loss is passed-through to owners personal tax returns. Any necessary tax is reported and paid to the IRS at the individual level.