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LLC vs. S-Corp

Dollar Bill

We receive frequent requests for consulting on what option is best for a new business – LLC or S-Corp. Due to the volume of such queries we feel it necessary to break out the advantages to each as well as a possible combined solution. So, without further to do....

The key benefit of an LLC:

An LLC provides limited liability and may be helpful for those who would like to attempt to limit possible lawsuits to their company.

The key benefit of an S-corp:

An s-corp allows for multiple members and also allows you to limit self-employment taxes that would be assessed on a single-member LLC.

Key Points on both entities:

An LLC is not an IRS filing status. It is an entity type that is allowed per the laws of each state. How is an LLC taxed? The IRS will create a default status based on membership. If there is only one “member” or owner, it is considered a “Single Member LLC” and will be taxed on your individual tax return on by filing Schedule C with Federal Form 1040. You will NOT be filing a separate business return in this case. Your entity is considered a “disregarded entity.” Although, you may obtain a unique EIN number for this entity and list the EIN on the Schedule C (Form 1040).

If there is more than one “member” to the LLC, the IRS will create a default filing status of the LLC to be a partnership (if you wish to know more about partnerships, please read our post on that topic). You are also required to file an informational return by filing Federal Form 1065. Be careful – these are typically due one month prior than your individual tax return (Form 1040) due date. This is automatically required per the IRS and the penalties for late filing are assessed per partner per month. If you do not file on time or file an extension this can add up to thousands of dollars quickly. All states also require a partnership tax return. The profits or losses will then “flow through” to its partners. No income tax is calculated on this form. The income and taxes “flow-through” to its partners and recorded on K-1s. The partners then report their partner income or loss on their Federal Form 1040. I digress!

The main purpose of an S-Corp filing is to reduce self-employment taxes. As opposed to income reported on Schedule C, the income reported on an S-Corp return does not flow to the Schedule SE. We use Schedule SE to report self-employment tax. Part of the profits derived from the S-Corp may be taken as a distribution, saving the shareholders in tax liability. An S-Corp election needs to be taken in order to get the preferential treatment. This is done on Federal Form 2553 and must be filed prior to March 31st of any given year. The election takes place on the date of the form or up to 75 days prior to that date. There are some late-filing election options available. Please contact our office to discuss this further.

Drawbacks to single member LLCs:

  • Self-employment taxes may be high at the federal level, depending on the profits of the business

  • Some states require separate annual filings.

  • Some states require separate fees to be assessed on the filing. These fees may be fixed or based on the income of the business.

  • You should to pay quarterly estimated taxes to the IRS as well as your state (if applicable) to avoid penalties and interest.

Drawbacks of an S-Corp:

  • Owners/shareholders must have reasonable wages depending on key points that include the nature of their work.

  • A filing of Federal Form 1120S is required.

  • In order to run payroll, you must also have unemployment insurance, worker’s compensation insurance, and in some states disability insurance. Missing any of these can lead to penalties. You must have the insurance in place or dated back to the first day an employee starts their job. Keep in mind that according to IRS the owner is considered an employee of the S-Corp and the S-Corp must adhere to the employment withholding rules.

  • You should to pay quarterly estimated taxes to the IRS as well as your state (if applicable) to avoid penalties and interest.

Our firm has extensive experience setting up LLCs, S-corps, partnerships, and payroll systems. We also provide HR outsourcing to ensure compliance requirements are met. This includes compliance with the various types of insurances and registrations necessary with your state and the IRS. Please feel free to contact us to discuss this further.

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