Llc Taxation And Fees
Limited liability companies are taxed differently from other corporations. An LLC allows pass-through taxation, which is when the business income or losses pass through the business and are instead recorded on the owner’s personal tax return. As a result, the profits are taxed at the owner’s personal tax rate. A single-member LLC is typically taxed as a sole proprietorship. Any profits, losses, or deductions that are business expenses that reduce taxable income are all reported on the owner’s personal tax return. An LLC with multiple owners would be taxed as a partnership, meaning each owner would report profit and losses on their personal tax return.
LLCs avoid the double taxation, which C corporations must pay because they pass all company income through to the tax returns of the individual owners. A C-Corporation is a legal structure for a corporation in which the owners, or shareholders, are taxed separately from the entity. C corporations, the most prevalent of corporations, are also subject to corporate income taxation. The taxing of profits from the business is at both corporate and personal levels, creating a double taxation situation.
The fees for establishing an LLC can vary by state but expect to pay nearly $500, which might include the following:
What Are S Corp And Llc
An LLC, or limited liability company, is a legal entity that can protect owners from personal liability in most instances. Meanwhile, an S corporation is a special type of corporation that meets certain requirements under the Internal Revenue Code. For starters and new business players to the US, you should be aware of this S corporations are tax statuses that can be elected by limited liability companies or corporations.
An LLC is not a tax designation. Rather, it is a legal structure that can provide limited liability protection for your business. Generally, an LLC tends to be a much simpler business structure than an S corp, but S corps can offer a few key benefits that LLCs do not.
In what follows, we dig into the details of each business structure, the benefits of S corp vs LLC so you can better understand the key differences between the two types and make an informed decision about which one is right for you.
What Is A Reasonable Salary
According to many CPAs we know, the unofficial rule is that a reasonable salary is equal to of the business profits.
So as long as youre doing this as an S-Corp, wed say you should be fine. Many people who are getting caught up with the IRS arent paying themselves a salary at all.
Now heres the good news.
For example, lets say you made $100,000 in income and paid yourself $70,000 as a reasonable salary.
Youd only pay social security and Medicare taxes on the $70,000 and would not on the difference of $30,000.
$30,000 × 15% = $4,500.00
Thats $4,500.00 in tax savings just from choosing the right entity.
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Ownership And Management Flexibility
Many company owners opt for this type of entity because of its flexibility in corporate ownership and management. An LLC can have many owners and be managed by them as well. The corporate structure is more rigid in different types of businesses like a corporation, where a board of directors must oversee the company.
Can An Llc Be An S Corp
An LLC is a state-chartered business entity that offers limited liability protection to its owners, while an S corp is a federally chartered legal form and tax status that can be elected by LLCs or corporations. Note that S corp is a tax status business owners can elect for their business. So, you as a business owner can incorporate an LLC and elect to be taxed as an S corp.
Keep in mind, there are certain requirements that must be met in order for the IRS to consider the LLC an S corp. Letâs check whether or not the LLC has only one class of stock and has less than 100 members, all of whom are US citizens or resident aliens, and other requirements.
If your LLC meets these requirements , it can elect to be taxed as an S corp by filing Form 2553 with the IRS.
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Schedule A Consultation With Our Kansas Business Law Attorneys
If you are comparing an S corporation vs LLC structure for your business or have other business law questions, we invite you to contact us. From our offices in Topeka and Lawrence, our Kansas business formation and planning lawyers at Sloan Law Firm assist owners of new and ongoing businesses with all types of issues relating to business management and operations, including business structure, taxation, commercial transactions, and employment law matters. Call us at 369-6311 or use our online contact form to talk with us about your business needs.
Should I Have My Llc Taxed As An S Corp
The right structure for your business depends on you, other owners and the business itself, but you should be aware of the benefits and drawbacks of having your LLC taxed as an S corp.
Having your LLC taxed as an S corp includes these upsides:
- The business pays your salary and its payroll taxes. This may save you money on taxes because, as with a regular LLC, you would pay self-employment taxes on the businesss gross income.
- Additional earnings are distributed to shareholders as dividends. This may also save you money, since dividends are taxed at a lower rate than income is.
Having your LLC taxed as an S corp includes these downsides:
- Theres a salary cap. You must establish reasonable compensation for owner-employees.
- There are limitations. Youre limited to one class of stock and 100 shareholders.
- Shareholders own more than 2% of the companys stock and cant claim employee health insurance as a tax-free benefit as they could with a C corp.
Having your LLC taxed as an S corp once you hit the $60,000-a-year mark is a great decision, according to Scott Royal Smith, founder and CEO of Royal Legal Solutions.
This allows you to divide the income between personal income and dividend income and gets you to a lower overall tax rate, Smith said. The drawback is that you also have to pay for an individual S corporation tax return at that point. You have to weigh the tax savings in what youre keeping from the government against how much the CPA is going to charge you.
Llc Vs S Corp Final Verdict
There is no right or wrong between the two options it all comes down to what is required for your business.
Incfile’s Corporation Formation team can help you weigh your options and decide which entity structure suits your current and future business needs. We’ve supported over 800,000 small business owners in kickstarting their LLCs, S Corps, and beyond. Tell us when you’re ready, and we’ll get you started on the right foot.
Swara Ahluwalia is a freelance content writer with experience in the technical, B2B and SaaS domain. She also has curated content for various lifestyle brands. In her downtime, you will most likely find Swara training for her next marathon or spending time with her two daughters.
Benefits Of An S Corp
- Pass-through taxation: As pass-through entities, S corporations are not subject to corporate income tax.
- Tax savings: Distributions taken beyond salaries are not subject to self-employment taxes and may be tax-free.
- QBI deduction on distributions: An S corporation can let high-income earners who would otherwise be phased out capture more of the QBI deduction.
- Access to investment capital: S corporations may have up to 100 shareholders, allowing the business to attract investment capital.
- Limited liability: Shareholder liability is limited to the amount invested in the business.
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Which Structure Is Better For You
For small business owners or sole proprietors, an LLC is often the easiest and most cost-effective way to incorporate. A business owner who wants to have the maximum amount of personal asset protection plans on seeking substantial investment from outsiders or envisions eventually becoming a publicly-traded company and selling common stock will likely be best served by forming a C corporation and then making the S corporation tax election.
It is important to understand that the S corporation designation is merely a tax choice made to have your business taxed according to Subchapter S of Chapter 1 of the Internal Revenue Service Code. An S corporation might begin as some other business entity, such as a sole proprietorship or an LLC. The business then elects to become an S corporation for tax purposes.
Choosing the right business structure will therefore depend on the size and scope of the company, the number of employees, the level of involvement of the owner, and tax considerations. While more complex business structures can allow for greater tax minimization and sophistication, they are also more expensive to create and maintain, often requiring the professional services of lawyers and accountants.
Which Is Better: S Corp Or Llc
It depends on what you want out of your business. Single-member LLC’s have relatively simple tax situations similar to those of a sole proprietorship, which gives them an advantage over S corps. LLCs are allowed unlimited members and can have non-U.S. citizens, whereas S corps are limited to 100 owners and cannot have non-U.S. citizens as shareholders.
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Should You Switch To An S
There are a few things to consider when choosing between an LLC and S-Corp, especially regarding each entitys tax savings.
Each one has its unique benefits and drawbacks.
This article will compare an S-Corp and an LLC and discuss the tax savings you can expect by making the switch. Lets get started!
S Corp Benefits And Requirements
The following criteria determine whether electing the S corp tax classification makes sense for an LLC:
- The LLC business owners must earn “reasonable compensation” or a “reasonable salary.”
- The business should consistently earn a profit and pay distributions.
- The financial tax advantage must offset the cost of maintaining the S corp.
- The business must meet IRS S corp requirements.
Under an S corp election, LLC owners become employees. The IRS requires owner-employees to be paid a reasonable salary, referred to by the IRS as “reasonable compensation.” A reasonable salary is any salary that you would pay someone to do the same job.
LLCs taxed as S corps are subject to increased scrutiny by the IRS. If the owner is not paid a reasonable salary, this may lead to the IRS denying S corp status and may lead to fines and back taxes.
Profit and Distribution
Positive Return on Investment
It costs money to elect and maintain an S corp. Filing fees with the IRS are minimal but the additional bookkeeping and payroll costs are not. For LLCs that already have employees and payroll costs, this factor won’t hold as much weight.
IRS S Corp Requirements
The IRS requires that businesses that elect the S corp status have 100 shareholders or less and they are only allowed to issue one class of stock.
Llc Vs S Corporation: An Overview
Choosing the right business structure is crucial to the success of your business.
An LLC is a limited liability company, which is a type of legal entity that can be used when forming a business that offers protection to the owner from personal liability for debts and other obligations that a business might incur. In other words, the personal assets of the owner cannot be used for legal claims against the business.
LLCs are common because they provide the liability that’s similar to a corporation, but they are easier to establish and with fewer regulatory requirements than other types of corporations. LLCs allow for personal liability protection, which means creditors cannot go after the owner’s personal assets. An LLC also allows pass-through taxation, meaning business income or losses are recorded and taxed on the owner’s personal tax return. LLCs are beneficial for sole proprietorships and partnerships. An LLC with multiple owners would be taxed as a partnership, meaning each owner would report profit and losses on their personal tax return.
An S corporation provides limited liability protection but also offers corporations with 100 shareholders or fewer to be taxed as a partnership. An S corporation is also known as an S subchapter. In some instances, a business may be both an LLC and an S corporation. A business must meet specific guidelines by the Internal Revenue Service in order to qualify as an S corporation.
Disadvantages Of An S
Because an S-corp will mean more complicated tax withholdings, you can expect your accounting fees to increase, especially if you wouldnât otherwise have employees and payroll expenses. An S-corp may also require separate tax filings. Therefore, it may only be worth operating an LLC as an S-corp when your company reaches a certain income threshold, and the additional costs and fees make sense from an accounting perspective.
If youâre on the fence about whether or not it makes sense to structure an LLC as an S-corp, itâs a good idea to speak to an accountant about the specific additional costs and the income threshold that justify the tax benefits of an S-corp. If you are just getting started with your business and are still unsure about how much income your LLC will generate, you may want to consider holding off on setting it up as an S-corp.
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An Llc May Be Best For You If:
You may want to establish an LLC if you’re concerned about personal liability but want minimal business upkeep. Legal requirements dictating the structure of an LLC are more lax than upkeep requirements for corporations.
Reporting requirements are generally simpler for an LLC than for a corporation. An LLC can have an unlimited number of owners. Partnerships, corporations, or noncitizens can own or partially own LLCs. The LLC should file an annual or biennial report that gives updates on current members, business locations, and other changes.
What Is A Reasonable S Corp Salary
As an employee-owner of your business, you get to decide what to pay yourself. With S Corp taxation, paying yourself a salary less than your total business profits could mean serious tax savings. To keep you from taking advantage of that option and skipping out on fair taxes, the IRS requires you to pay yourself reasonable compensation.
It doesnt clearly define what is reasonable. A general rule is that it has to be at least what other businesses pay for similar services. What would you earn if you were employed by another company to do what you do for your business?
You can adjust your compensation based on your businesss unique circumstances, including:
- How much of the businesss profits are directly attributable to your efforts versus things like employees, property sales, and passive income.
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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.
Why Would You Choose An S Corporation
An S corporation provides limited liability protection so that personal assets cannot be taken to satisfy business debts by creditors. S corporations also can help the owner save money on corporate taxes since it allows the owner to report the income that’s passed through the business to the owner to be taxed at the personal income tax rate. If there will be multiple people involved in running the company, an S-Corp would be better than an LLC since there would be oversight via the board of directors. Also, members can be employees, and an S-Corp allows the members to receive cash dividends from company profits, which can be a great employee perk.
The Downsides Of S Corps
The solidity and tax savings of S Corps also come with some caveats. Since S Corps are separate structures, they require scheduled shareholder and director meetings. In addition to minutes being recorded from these meetings, other requirements include updates to bylaws, adoption, records maintenance, and stock transfers.
Another issue is that not all states treat S Corps the same. Most states recognize them similarly without double taxation with the IRS. However, California, as an example, taxes S Corps at either 1.5% of its net income, or $800 , which is in addition to the income tax that shareholders are required to pay on their share of the S Corps income.
Another disadvantage of S Corps is that employees/shareholders will not be able to claim tax benefits on the business expenses they incurred. Because employees/shareholders are considered employees of the company, any unreimbursed business expense shall be treated as unreimbursed employee expenses, which are only tax-deductible for California income tax purposes subject to 2% of adjusted gross income .