When it comes to choosing the right business structure for your company, there are two options that typically come to mind. Setting up a Limited Liability Company (LLC) or an S Corporation is going to be something you need to do, but knowing which is going to suit your needs can be complicated. It’s important to fully understand what you are getting yourself into before making any decisions, so let’s take a look at everything you need to know about LLC vs S Corp.
The difference between LLC vs S Corp
First and foremost, LLCs and S Corporations are not actually the same type of companies. In fact, an LLC is a legal business structure, but an S Corp is actually a supporting tax classification. It means that an LLC can be taxed as an S Corp (this ability is limited depending on qualifying factors), as opposed to under different tax protocols.
If you think that establishing an LLC of your own could be worthwhile or that using S Corporation taxation could be of benefit, doing some extensive research and finding a good team to help you in your endeavors can be your best asset.
What is an LLC and how does it work?
In the simplest terms, an LLC is a blend of a business partnership and a corporation, in the sense that your personal assets will be separate (and therefore protected) from those of the company you work for (or are running). As a single-functioning entity, owners are known as members, and LLCs can be operated by either one or multiple individuals. These are typically chosen by small and medium-sized businesses, as well as by entrepreneurs, as they can offer a better level of flexibility than some of the other business structure options out there.
With the above in mind, you may be interested to know that they function differently from standard partnerships and corporations in that the IRS doesn’t tax them under their own category. Instead, they are treated the same as sole proprietorships and partnerships. They have options to be taxed as S Corporations or C Corporations for a more tailored approach.
What is an S Corp?
As a tax classification, corporations can be taxed under the S Corp umbrella, just like an LLC can. There is no corporate income tax (which you will get with a C Corp); company profits are addressed via the owners’ personal tax returns.
To qualify for S Corp taxation, you will need to be a US-owned and operated business with no more than 100 shareholders (owners). The good news is that shareholders can be individuals or trusts and estates, but the latter two will have their own restrictions. As long as you only have one class of stock and shareholders aren’t non-resident aliens, corporations, or partnerships, you should be free to make use of S Corp taxation for your business. With LLCs, non-US citizens or residents can be members or shareholders, so this may be worth keeping in mind.
Who pays more taxes: LLC vs S Corp?
When you operate your business as an LLC, you will be seen as self-employed and taxed as such, just like a sole proprietorship or partnership. It means that you will be expected to:
- Report your own business income and expenses via personal tax returns
- Pay federal, state, and self-employment tax (including Medicare and Social Security)
By choosing S Corp taxation, self-employment doesn’t have to be your only option for the status of your business, so you can class yourself as an employee of the company and be paid via the regular payroll system. This will negate some of the additional fees, but Medicare and Social Security taxes will still apply (any company profits that end up being above your salary won’t be affected).
This isn’t as good as it may seem though, as you’ll find yourself being subjected to a thorough IRS investigation that goes further than the standard protocol. They will be looking out for your accuracy when submitting tax returns to ensure you’re declaring all of the necessary information. You will be penalized if they think you’re trying to portray a lower income.
One of the best things you can do is get advice from a professional company specializing in business taxation, as setting up an LLC vs S Corp can be more complicated than you may think. Selecting the right one could help you to minimize your tax returns without running the risk of being flagged and facing significant fines.
Benefits of creating an LLC vs S Corp
The benefits of creating an LLC vs S Corp can be varied, so here’s a quick overview:
- More flexibility in management
- Fewer provisions than corporation laws
- No annual shareholders’ meetings and directors’ meetings required
- LLCs can be managed by members or managers depending on the businesses needs
- Better flexibility regarding an individual’s financial interests
As both are pass-through entities, no income taxes will be paid at the business level (although an LLC can opt out of this if they have different needs or requirements). These are passed through to the owners’ personal tax returns. Reporting and paying taxes at an individual level could be better for your business for various reasons, so be sure to do your research.
How to change LLC to S Corp
The good news is that switching from an LLC to an S Corp doesn’t have to be difficult. As long as your business meets all of the requirements that the IRS stipulates, you should be able to simply send an application and start enjoying the benefits. The best thing is that you won’t have to modify your existing business structure once you qualify. Remember that it can be extremely beneficial to get advice before doing so, as there can be financial consequences that you may not be prepared for without expert help.
Workhy helps you make the right decision for your business
Are you tempted to make your LLC work better for your business? Bringing in S Corp taxation could be the way to go – but you need to have an established LLC first. With the skilled team at Workhy by your side, getting set up will be a breeze, and you’ll be reaping the rewards in no time at all.