Which is Right for You – S Corp or LLC?

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Are you a small business owner? Are you confused about the differences between a S Corporation or an LLC? It’s important to discuss the similarities and differences between these two entities to determine which is right for you.

The main difference between an LLC and an S Corp comes down to taxes. Income generated by an LLC is considered taxable personal income. While, in an S Corp, you can deduct business expenses from a company’s taxable income.

What is an LLC?

An LLC or limited liability corporation is a business entity that is legally separate from its owners, who are known as “members.” An LLC can have one member or many members. Small business owners often choose to form an LLC instead of a corporation because LLCs offer more flexibility in the way they are managed and usually have fewer record-keeping and reporting obligations than corporations.

What is an S Corporation?

Unlike an LLC, an S corporation is not a type of business entity. The S corp designation refers to the way a business has chosen to be taxed under the Internal Revenue Code (IRS). For tax purposes, the IRS classifies businesses as sole proprietorships, partnerships, C corporations, or S corporations. There is no “LLC” tax classification so LLCs are taxed as though they are another type of business. The IRS automatically taxes single-member LLCs as sole proprietorships and multi-member LLCs as partnerships. But an LLC can also choose to be taxed as a C corporation or as an S corporation.

The major difference between sole proprietorship LLC taxes and LLC taxed as S corp. taxes is in the way small business owners pay Medicare and Social Security taxes (self-employment taxes). It is possible for some LLC owners to save money on these taxes by choosing S corp. taxation.

Which is Right for your Small Business?

The IRS’s S corporation definition makes it clear that not every business qualifies to be taxed as an S corp.

Remember: Multi-member LLCs that have more than 100 members also cannot be taxed as S corporations.

Most single-member LLCs will qualify, but you can’t choose S corp. taxes if your single-member LLC:

  1. Is a foreign LLC
  2. The owner is a nonresident alien
  3. It is structured so that the owner is actually a corporation or partnership

In order to evaluate the benefits of S corp. vs. LLC taxation, you must consider whether changing to S corp. tax status will save you money. If your business profits are greater than your reasonable salary, S corp. taxation may save you money. Consider also that your tax return will be somewhat more complex and, if you don’t have other employees, you will have to set up tax withholding. An experienced CPA can advise you on other benefits and consequences of choosing LLC vs. S corp. taxation for your business.

You will need to determine what a reasonable salary for a person who does what you do would be. The IRS scrutinizes owner-shareholder salaries, so it is vital not to set an artificially low salary for yourself. Then ask, if you paid yourself that salary, would your business have any profit left over? If the answer is no, then S corp. taxation may not help you.

It’s critical to note that if you’ve already formed your LLC but are unsatisfied with the resulting tax consequences, you can change your tax status. In general, you can elect LLC S corp. status at any time during the tax year prior to the year you want the election to take effect, or during the first two and a half months of the current year. Note that new businesses have approximately 75 days to elect a different tax status.

As you may have inferred, it’s wise to speak to an experienced attorney and accountant in tandem to decide which tax status is right for you.

I built my law practice on the premise of being a life raft in a sea of sharks. I want to be an advocate for those that have been wronged and are too intimidated to seek help. My firm is here to explore your options, guide you through your legal journey, and give you that safe space to ask questions! There’s no such thing as a stupid question…Only the ones you don’t ask. So, my question to my clients is not “do you have any questions?” But rather “what questions do you have?”

As always, the Kazi Law Firm is standing by to help you in your time of need. Don’t hesitate to contact us today. We specialize in real estate law, landlord-tenant disputes, immigration, and wills & estate planning. Family is at the core of our practice. Just as we treat our family with respect and understanding, we treat yours. Come join the Kazi Law Firm family today!

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