Should I Start an S Corporation or an LLC?

For first time business-owners who aren’t familiar with the many different business structures that exist today, the first steps to turning your ideas into a profitable venture may seem daunting. 

Today, we’ll be focusing on the two most common types of structures that small business owners choose – S Corporations and LLCs. So, if you’re a small business owner asking yourself “Should I start an S Corporation or LLC?” here’s all the info you need to consider when making your decision.

Limited Liability Company – or more commonly known by its abbreviation LLC, is a business that is structured legally in a way that separates the business’s assets from its owner’s assets.

Therefore, this means that the LLC, as a business, is a financially distinct entity, entirely separate from the owner of the company. In the case of a bankruptcy or insolvency, the company’s assets can be reclaimed, but the owner’s legal assets will be protected from action by any of the business’s creditors.

LLCs can be a single-member, or a multiple-member entity. It is one of the most recent forms of business entities available in the U.S. and is thus more flexible when it comes to management, profit-sharing, and liability protection. Most people refer to it as a hybrid between a corporation and a partnership. 

According to the IRS, LLC owners and sole proprietors are required to report revenue, expenses, and profits with a Schedule C (1040) form. 

You pay regular income tax on all the profits that your business earns in that tax period. 

dditionally, LLC business owners have to pay self-employment tax, which includes tax contributions to Social Security and Medicare for both employer and employee.

While registering an LLC may appear slightly cheaper than registering an S Corp at first, in total, you’ll be paying 15.3% of your yearly business profits in self-employment taxes.

What is an S Corp?

By definition, an S Corp isn’t exactly a business entity – it is a tax classification that the U.S government uses to associate tax liability for businesses in the U.S. Both LLCs and Corporations fall under the S Corp umbrella, as they can be taxed as an S Corp.

However, you need to meet the following conditions in order to qualify as an S Corp. You must be a genuine U.S Business, with less than 100 shareholders that cannot be corporations, non-resident aliens, or partners, and you can only offer one class of stock.

S Corps don’t pay corporate income taxes like a C Corp does – all company profits at the end of the filing year goes to the owner’s personal tax returns. Additionally, S Corp structures protect the owner from having their business profits taxed at both the corporate and shareholder level.

Basically, if you, as a business owner, use an S Corp structure for your business, you are allowed to be a company employee under the company payroll, saving you a considerable sum of money on taxes.

Which one should I choose?

LLCs are simple to set up – the paperwork is minimal and is a fairly straightforward process when it comes to dealing with the IRS when it’s tax return time. However, each owner’s share of the company profits is subject to federal and state (variable depending on where you are located) taxes, in addition to self-employment (Social Security, Medicare) taxes.

However, for business owners who set up S Corp taxation structures for their LLC, they can become an employee of the company, paying themselves through the company payroll and thus reducing their tax liability when it comes to company profits.

This is advantageous for business owners, but it comes with additional scrutiny from the IRS. They take a very close look at LLC businesses with S Corp tax structures to ensure that filed salaries are accurate and not unreasonably low, based on industry and geographical location standards.

The bottom line is, if you’re choosing to register your LLC as a regular LLC, you’ll be doing things pretty straightforward – your paperwork will be minimal, as long as you follow the instructions given by the IRS to register your business.

And if you do choose to go the S Corp tax structure route, you’ll need to be very careful with your payroll, salaries, and profits when you file your company taxes. The IRS can and will impose heavy fines to those who try to take advantage of the system by classifying their income as 0% and 100% distributions.I

If you want to know more about the differences and see a full comparison on Incfile (our recommended business formation service) please click here or the button below:

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