Are you thinking of starting a business or have you run a sole proprietorship and think you are ready for a business structure change?
Most new business owners choose between the LLC and S Corp. Both entities offer personal liability protection and tax benefits. How do you choose between the two? We’ll discuss the benefits of each below.
What is an LLC?
As the name suggests, the LLC or Limited Liability Company separates your personal life from your business. You’re only legally responsible for as much as you invested in the company. Creditors can’t come after you personally if you can’t satisfy your liabilities beyond what the business can afford.
What is an S-Corp?
An S-Corp also limits your personal liability, but it has stricter regulations. An S-Corp isn’t a business entity but it determines how your business is taxed. S-Corps offer more tax protection than LLCs, which aren’t a tax designation. As the owner, you pay yourself a reasonable salary and the rest are profits, which have a different tax rate, saving you money on your taxes.
Considerations of an LLC
· Less paperwork – As a ‘pass-through’ entity, all income is personal income. You only file a personal tax return, not a business tax return.
· Affordable to set up – You can usually set up an LLC for a few hundred dollars. Its simplicity reduces the assistance needed from an attorney or accountant.
· Financial protection – You can’t be personally responsible for business debts or liabilities.
Considerations of an S-Corp
· Financial protection – Like the LLC, the S-Corp protects you financially from any business debts or liabilities.
· Lower tax liabilities – S-Corp owners pay themselves a reasonable salary. You pay both sides of the taxes on this income but on not the company profits. You don’t pay Medicare or Social Security taxes on the profits.
· Stricter regulations – Since the S-Corp is a tax classification, the IRS has strict guidelines including who qualifies and how many stockholders you may have (LLCs don’t have this restriction).
· You must qualify for an S-Corp, which means the business can’t be a foreign LLC, you can’t be a non-resident alien, and the business must be structured as a corporation, such as an LLC.
What Should you Choose?
Choosing between an LLC and S-Corp comes down to the profits. Will forming an S-Corp save you money? What is a reasonable salary for your industry? Do you make much more than a reasonable salary? If so, an S-Corp may save you money on your taxes since only your income gets fully taxed. You can pay yourself the profits, but only pay FICA and unemployment insurance on the profits, not Social Security and Medicare taxes.
If you don’t bring in more than a reasonable salary, it may not be worth the cost to form an S-Corp. The paperwork and the fees make it more complex. However, any business can create an LLC and protect themselves financially. In fact, you can form an LLC and get taxed as an S-Corp. This reduces your tax liability, putting more money in your pocket.