LLC v S-Corp for the New Business Owner

LLC v S-Corp for the New Business Owner

July 1, 2019 0 By Nate Riordan

Bottom lining the choice between a Limited Liability Company and an S Corporation for the new business owner 

Lawyers and accountants are guilty of a lot of blah blah blah around entity selection. Let’s cut to the chase. If you are a new business owner just starting out with a business, there are really two choices: s corporation (s-corp) or limited liability company (LLC). Here are the things you need to focus on to decide which one to use.

The entity shield protections are the same for both, with some remote caveats that aren’t worth getting into the weeds over. There are limitations on how many shareholders an s-corp can have (it’s 75), you have to be a US citizen.

LLC v S-Corp

If you are going to have partners, the LLC is just more flexible when it comes to taking money out and accounting for it at the end of the year. In an LLC – owners – called members – can take different distributions and accounting for those distributions is easier. It is easier to have different classes of ownership interests with different economic and voting rights in an LLC. If this sounds like your business, or if you think there’s a good chance this could be your business, then form an LLC.

In an s-corp, all shareholders must be treated the same, and if you mess that up, you can lose the s-election. We won’t go into exactly what would happen or why that’s bad, let’s just leave it at that it would be bad. Fixable, avoidable, but bad. If it is just you, or just you and a spouse, this really isn’t a concern.

Here is the difference between the s-corp and the LLC from a money-saving perspective

  • First, the LLC doesn’t have to file a separate tax return. That’s a convenience, as well as a saved expense.
  • Second, and here’s the difference, there’s a tax saving in the s-corp. Strap in, here comes some math:

Both the LLC and the s-corp are “pass-through” entities for tax purposes. That means the tax attributes of the entity – profit and loss – pass through the entity to the owner’s tax return. The entity pays no taxes.

In an LLC, if there is a profit, the owner will pay federal income tax on the profit. However, the owner will also pay self-employment tax on the profit. Self-employment tax is designed to replace payroll tax. If you look at your paystub, there are deductions for FICA, FUTA and Medicare. Those payroll taxes come to 15.3%. As an employee, half of that is deducted from your side of the paycheck. The employer pays the other half. If you own an LLC and are active in the business, you pay the whole 15.3% on all of your LLC’s profit in addition to federal income tax. As a single member LLC owner, you don’t typically pay yourself a salary. Even if you did you would still owe self-employment tax.

In an s-corp, you have the right to take a salary up to the amount that you would have to pay someone to do your job. Let’s say that’s $100,000 and you pay yourself that amount. You pay payroll tax on that $100,000. Here’s the magic of the s-corp: the rest of the profit is taxable at the federal income tax rate only. No self-employment or payroll tax.

LLC v S-Corp 

LLC v S-Corp

 

That means that in an LLC, if you have a profit of $200,000, in addition to federal income tax, you pay 15.3% self-employment tax on that profit. In an s-corp, if you have a profit of $200,000, you  can take $100,000 in salary (or whatever salary you think you can justify), pay payroll tax on that salary, and then take the next $100,000 (or whatever the remainder would be) and pay only federal income tax on that profit. In our example, that’s a savings of $15,300 in self-employment taxes.

Yes, yes, an LLC can file an election to be taxed as an s-corp. If you really want to get scary with all this stuff, please call us and we’ll talk your ears off about LLC v S-Corp.