Tax Issues
LLC vs. S Corp
There are generally two main reasons for forming either an S Corporation or an LLC. First, the owner(s) of both of these entity types may enjoy limited liability protection. Second, there are opportunities in both entities to allow owners to reduce the amount of income subject to self-employment taxes.
S Corporations
The main advantage an S-Corporation has over an LLC is the fact that S Corporations have been around for a long time. IRS statutes and regulations and significant case law history have clearly defined how to treat most situations in an S Corporation. There is really no ambiguity on how to establish, operate, report earnings and expenses, and liquidate S Corporations.
One of the main reasons many small business owners choose an LLC over an S Corporation is because owners of S Corporations who also work for the company are required by the IRS to receive reasonable compensation for the services they provide. (Click on the link below for guidance on reasonable compensation from the IRS). That means they are required to file quarterly and annual payroll tax returns and issue W-2s at the end of the year. If returns arent timely filed then penalties may be assessed.
Limited Liability Companies
While LLCs are less predictable than S Corporations because of a lack of IRS guidance or case law, members of LLCs enjoy greater flexibility. There are no payroll requirements for LLC members as there are for owners of S Corporations. Allocations of profits, losses, capital, distributions, etc. do not have to be based upon ownership percentages. Members of LLCs still benefit from liability protection and the opportunity to reduce the amount of income subject to self-employment tax.
Example:
Roy is married, has no kids, has a mortgage, donates cash to his church, and is self-employed. His mortgage and property tax add up to $10,000 and he makes charitable contributions of $5,000. His business generates $100,000 revenue. His business expenses add up to $50,000. That leaves a taxable profit of $50,000.
Sole-Proprietorship
Roy will pay income tax (approx. $2,960) on $50,000 gross income ($50,000 profit from self-employed business). Roy will also pay self-employment tax (approx. $7,268) on the profit of $50,000 from his self-employed business. The total tax bill is $10,228.
LLC
In order to benefit from a reduction in self-employment taxes, Roy and his wife, Karen form a multi-member LLC that will be taxed as a partnership. For the sake of simplification, her ownership percentage is so low all the profits go to Roy. Roy pays himself $17,000 in guaranteed payments for his services, which reduces the businesss profit to $33,000. Roy will pay income tax (approx. $3,320) on $50,000 gross income ($33,000 LLC profit + $17,000 guaranteed payments). Roy will only pay self-employment tax (approx. $2,471) on $17,000 from guaranteed payments. The total tax bill is $5,791.
S-Corporation
Roy forms an S Corporation which he owns 100% and pays himself $17,000 in wages for his services, which reduces the businesss profit to $33,000. Roy will pay income tax (approx. $3,320) on $50,000 gross income ($33,000 LLC profit + $17,000 W-2 wages). The company and Roy will pay employment taxes (approx. $2,471) on $17,000 from W-2 wages. The total tax bill is $5,791. The employment taxes will probably be due at least quarterly and the company will also be required to pay federal and state unemployment taxes (approx. $255). The company will be required to file quarterly/annual payroll tax returns and issue a W-2.
In this case, Roy chooses to be an LLC because he will save about $4,437 in taxes and wont have to bother with payroll reports and requirements.
LLC S Corp
Self- Pays self-employment Reasonable compensation
Employment taxes on guaranteed to owners who provide
Tax payments to owners who services for S Corp
provide services for LLC
According to operating Must be done according to
Distributions agreement - can be ownership percentages
distributed unequally
Must have at least 2 Able to have only one
Owners owners to benefit from owner but may not have
self-employment tax more than 75 owners;
savings other restrictions apply
IRS Filing 1040 Sched C, E, or F, 1120S
Requirements 1065*, 1120, 1120S
Some states have
State Filing unfavorable minimum No minimum taxes in Utah
Requirements taxes for LLCs; Utah has for S Corporations
no minimum LLC tax
Annual Not required Required
Meetings
* Most common
