Knowing the difference between business structures will save a lot of time and money down the line especially when it comes to paying taxes. If you are thinking about starting an LLC or S Corp and are not too clear on which one will best suit your business, the following guide will explain key differences between two, as well as clarify that an S Corp should not be confused with a business structure.
What is an LLC?
An LLC, Limited Liability Company, is a formal business structure consisting of either one member, referred to as a single-member LLC, or more than one member, referred to as a multi-member LLC. It’s easy to form an LLC and the start-up price will be different depending on what state the business operates in.
One of the key features of an LLC is personal liability protection, unlike a Sole Proprietorship where personal assets are not separated from the business, an LLC’s business assets are separated from personal assets – this is a similar feature that one gets from a Corporation business structure.
An LLC has pass-through taxation that a sole proprietor or partnership business structure has. Profits are taxed once and all profits go to the business owner who then records it on their tax returns.
What is an S Corp?
An S Corp, or S Corporation, is an IRS (Internal Revenue Service) tax classification and both LLCs and Corporations can use an S Corp, however, the business structure will determine the S Corp’s structure. S Corporations have pass-through taxation; any profits made in the business go to the owner, therefore, avoiding double taxation.
LLC vs S Corp
When LLCs file taxes they can either use the Default LLC or S Corp classification, however, both have differences, which we will look at below:
Using the Default LLC Tax Classification
The Default LLC tax classification is ideal for business owners who want to reinvest their money into their business to facilitate business growth, this does not require a substantial salary or distributions and the business often earns a smaller profit between tax years – a greater number of small businesses will use this tax classification.
The business owner will also pay FICA (Federal Insurance Contributions Act) and income tax on any profits or distributions that are available. Considering pass-through taxation, there will be a minimal amount of net income (income after various deductions) from the business that will pass-through the individual tax returns of the LLC members.
Various businesses, or LLCs, will find bookkeeping services cost more than the return on investment from the benefits that come with tax from an S Corp, therefore it’s recommended that they remain within the Default LLC tax classification.
Using the S Corp Tax Classification
With the S Corp tax classification, business owners are taxed as employees, but this is only feasible if there is a consistent profit that is substantial enough to be a salary with distributions. The business owner will also pay FICA (Federal Insurance Contributions Act), which includes Social Security and Medicare tax, as well as income tax.
The key contributing factor that will make an S Corp viable to use is if there is a reasonable salary with distributions, if this is not the case the business can be fined by the IRS – this can be ensured if the business earns an annual distribution of over $10, 000 after paying the relevant salary.
The costs of using an S Corp will be substantial, however if the business is already well-established and consistently pays employees the costs of bookkeeping and maintaining payroll will be manageable.
It’s important for LLCs to decide on the appropriate tax designation for their business, which is determined by the profit earned in the company. Visit the TRUiC website for more details and an in depth comparison on the difference between LLC and S Corp.