S Corp vs LLC – Which is Better for Taxes?
If you own a small business, you may wonder if you should file as an LLC or S Corp. Both options offer pass-through income, but an S-Corp has more tax benefits that you should be aware of to help you decide.
S Corp vs LLC – What’s the Difference?
An S Corp is a tax status for companies, including LLCs. By making yourself a shareholder, you can report your business income for working for the company, but you won’t have to claim any distributions you get as self-employed income.
LLC income is subject to self-employment taxes, which include 12.4% up to the Social Security wage base (which is adjusted annually) and 2.9% Medicare on all earnings.
S Corp vs LLC – What are the Tax Benefits?
To understand the tax benefits of an S Corp vs LLC, you must understand how each entity works.
If your company is an S Corp, you are an ‘employee’ in the eyes of the IRS. You pay yourself a reasonable salary according to what’s standard for the industry, and only pay self-employment taxes (15.3%) on that amount. Any remaining funds that you receive are distributions and are only subject to your personal tax rate.
If you run your company as an LLC, all income is pass-through income. In other words, you pay self-employment taxes on 100% of your earnings.
How do you Decide?
Many factors play into whether you should file as an S Corp or LLC, but one major factor is your company’s profitability.
When you draw a salary from your company, do you have a lot of money left over? If so, an S Corp would be your best bet. You can take the remaining income as distributions and only pay personal income tax on it – not self-employment tax.
This typically saves business owners thousands of dollars in taxes.
But there’s a downside – S Corps have much stricter filing requirements and more advanced paperwork.
To decide, look at the big picture.
See how much of your income you could offset from the self-employment tax by taking it as a distribution rather than a salary. You must be careful that you take at least as much of a salary as is ‘normal’ for the industry, so it doesn’t look like you’re trying to cheat the system.
This is the amount you’d pay both personal income tax and self-employment tax on. Any remaining income would be subject just to personal income tax.
If your business isn’t very profitable, and your salary takes most or close to most of the money the business brings in, then it may not be worth the hassle that S Corps create with paperwork and other requirements.
S Corp vs LLC is a common debate and is one that you should think about carefully. If your business brings in a lot of profits, it can benefit you to offset the self-employment taxes by creating an S Corp and drawing a salary. Just remember its downsides including the filing requirements and fees.
For more information, guidance, planning and tax preparation services, reach out to the tax experts at Murtha and Murtha CPAs.