S Corporations vs LLCs. A Limited Liability Company (LLC) is a type of business entity, while an S corporation is considered a tax classification.
While S corporations and LLCs aren’t exclusive, they’re still thrown into the same boat where taxes are concerned. LLCs are better known as limited liability companies and they are a type of business that can be formed. S Corps on the other hand are tax classifications and business owners can choose to have their business entities taxed in this manner.
Within the business world, owners are constantly searching for various ways to attain benefits for their companies, and using the S Corp certainly has its benefits. However, before you rush off and take advantage of these benefits, it’s a great idea to learn how or when they come into action. For the average or even above average Joe, understanding the structure of taxes might be tricky but it’s crucial for the development of your company.
LLC And S Corp Basics
As previously stated, S Corporations are better known as tax classifications while LLCs are companies. However, corporations and LLCs can be classified in the tax bracket known as the S Corp. In order to file for this, you’ll need to ensure that you file with the IRS. Before starting your business, it’s also a good idea to think about the financial and legal aspects of your business.
What Should You Consider Before Making Business Decisions?
What Is A Limited Liability Company?
LLCs are better known in the business world as a company that is formed by one or more persons. However, with the formation of an LLC, the personal assets of the owners are kept safe and away from any liabilities that may ensue. Hence, there is a strict barrier between the business entity and its owner.
LLCs with one owner are said to be single-member owned while those with more than one owner are considered multi-member owned. While owning your own business is a great achievement, LLCs are somewhat partnerships and come with a ton of advantages. Some of these include simplicity and flexibility to name a few.
Unlike many others, the LLC is widely popular in the startup world. When LLCs are formed, they usually have better alternatives to profit-sharing and management tactics. Additionally, they even provide excellent coverage for liabilities that are not applied to regular partnerships or sole proprietorships.
However, it should be noted that these companies never really receive a taxation category of their own and are taxed just like partnerships or sole proprietorships. For the most part, these details are usually dependent on the owners involved.
What Is An S Corp?
S Corps are taxation categories and not really a company. Corporations and LLCs alike can be lumped into this category if their owners desire. Unlike a C Corporation, S Corporation companies are not required to pay corporate taxes. In this situation, profits are simply given to the owners in the form of returns.
With that said, the benefits of S Corps, are not given to all businesses. The following are criteria that must be fulfilled in order to be classified as an S Corp:
- Your business must be located within the US
- Your shareholder list must not exceed 100 persons
- Shareholders include estates, trusts, and individuals
- Partnerships, corporations, or nonresident aliens are not considered to be shareholders
- Only one stock class will be granted at a time
When compared to sole proprietorships, LLCs and corporations reap many taxation advantages. As company profits are generated, using the S Corp will allow business owners to avoid double taxation. With the S Corp, business owners are thought of as being company employees and they get the opportunity to save on both taxes and money.
LLC Vs. S Corp – Similarities and Differences
Where both are concerned, it’s not a difference of which is better. Simply put LLC owners can run their business entities and be taxed according to the rules and benefits that comply with S Corps.
Before you establish your LLC and file to be an S Corp, you’ll need to put some thought into a couple of things.
By default, all LLCs are taxed as either a partnership or a sole proprietorship. Business owners are usually required to submit tax returns since they are self-employed. Hence, expenses and income for the company are reported in these forms.
However, it should be noted that all earnings are subjected to self-employment, state, and federal taxes. The current rate applied to those who are self-employed is 15.3%.
Hence business owners are required to pay this amount until they reach their maximum social security contribution. With the use of the S Corp, owners can now save some money on these taxes.
S Corp status allows business owners to be a part of the company and be considered as an employee. As such, they receive a salary through their payroll system. However, employee salaries are subjected to Social Security and Medicare taxes.
While you may be considered as an employee, the IRS pays close attention to ensure that your salary goes in line with your experience, your location, and industry regulations.
To illustrate, a small example will be used. If you made $100000 in profits as the owner, another person doing the same job can earn $70000 as an employee. When taxes are applied, you’ll be taxed on a total of $100000.
With S Corp benefits, you’ll only be required to pay taxes on the $70000 since you are an employee of a company. However, the remaining $30000 will be subjected to regular income taxes. As a result of the benefits, S Corp owners usually take full advantage.
Hence, LLCs utilize 100% distribution with zero percent salaries which allows them to escape payroll taxation.
However, the IRS has caught on to this trend and has implemented several harsh penalties for those using such tax avoidance methods. So, before you decide on the classification of your business entity, it’s a great idea to consult with your accountant.
An accountant will give great advice and they will even aid with determining a reasonable wage. While there are several advantages of being classed as an S Corp, you’ll be faced with multiple expenses such as payroll and employee salaries.
Even though LLCs can be taxed using S Corp status, this doesn’t always go as planned. S Corp status prevents various individuals from owning company stakes. Profit portions are also affected when companies use the S Corp status.
If you’ve never heard the term before, an equity partner is simply those who invest their funds into a company in the same way as the owners do. LLCs are known for having multiple members but those being classed as S Corp could only have a max of 100. The possibilities of LLC ownership are endless and LLCs are not subjected to the same regulations as corporations.
How To Structure Your LLC As An S Corp
To schedule your LLC as an S Corp, you’ll need to submit certain documents to the IRS along with the taxation documents for your company. Hence, Form 2553 must be submitted and elections should be made within a period of two months and fifteen days before the new tax year begins.
When Should Your Business Convert To An S Corp?
Forming an LLC has many advantages and can bring a ton of rewards. Most if not all business owners are usually enticed by the taxation benefits. However, in the case of corporations, there are various laws that require directors, executives, minutes, and board meetings.
If you’re interested in converting, as soon as your company acquires the necessary income to change the structure, this just might be the perfect moment.
S Corp Disadvantages
With the S Corp status, your overall accounting fees will increase due to tax withholding. In the case where you don’t have payroll costs or employee salaries to pay, those fees will be through the roof. S Corps require their own taxation documents and changing your status to S Corp is only beneficial when your company is generating suitable amounts of cash.
Hence, the extra expenses and costs don’t always stand up from an accounting point of view. So, if you’re unsure what’s best for your company, it’s a great idea to consult with your accountant to ensure that you make back your ROI in the midst of all of these expenses.