There are about 627,000 new businesses that start every year in the United States.
If you are getting ready to start your own business, or if you want to do business in the U.S., you need to make sure that you set up your business properly from the start.
Many choose to become a sole-proprietor, but there are a number of liabilities in doing so. Others will choose between an LLC and an S corp. Both offer advantages and protections that you wouldn’t get as a sole-proprietor.
Keep reading to compare the differences between an LLC vs S corp and how you can decide which one is right for your business.
What Is an LLC?
An LLC is a limited liability corporation. This type of corporation comes in many different forms. There are single-member LLCs, partnerships, and multi-member LLCs.
The biggest advantage of forming an LLC is that it gives you liability protection. In a legal sense, you are treated separately from your business. If your business ever ends up in court, only the business assets are at risk.
As a sole-proprietor, you don’t have any liability protection. You are your business from a legal perspective.
Where you file your LLC matters, too. Some states like Wyoming give limited liability companies more leeway if a legal dispute should ever arise.
What Is an S Corp?
Believe it or not, an S corp isn’t really a form of corporation. It’s a way that a company gets preferred to be taxed by the IRS. As an S corp, you have a salary that you draw from the S corp and pay income taxes on. If there are leftover profits from the business, you then take a corporate distribution on the profits.
This must be a reasonable salary. Paying yourself a $1 salary to save on taxes will catch the attention of the IRS and trigger an audit.
S corps may seem like a good way to save on taxes, but you have more paperwork to handle. Your taxes are more complicated as an S corp, which will make filing more expensive.
Can a Sole Proprietor Be Taxed as an S Corp?
No. That’s not the case. You’d have to create a single-member LLC and register that with the state. You’ll then need to create a business bank account (if you don’t have one already), and get an EIN from the IRS.
You’ll also have to fill out Form 2553 within 2.5 months after the start of your tax year. Most businesses use a standard calendar so their tax year starts on January 1. That means you have to file Form 2553 by March 15.
Remember that you’ll have more tax forms and responsibilities as an S corp. You’ll need to file Form 1120S by March 15 (your new tax deadline), a Schedule-K, Forms 940 and 941.
You also have to deal with state taxes.
Why File as an S corp?
The biggest advantage of electing to be taxed as an S corp is that you may be able to save on your federal income taxes. As an LLC or sole proprietor, your personal and business taxes are treated the same.
The business profit is your net income, which you pay income taxes on and 15.3% in self-employment taxes. Self-employment taxes are your contributions to Medicare and Social Security. ds
Let’s say that your net profit was $70,000 for the year. You’d pay your income taxes and about $10,710 in self-employment taxes.
As an S corp, you can pay yourself a salary of $35,000 a year. You’d pay income taxes and half of the Medicare and Social Security contributions.
The corporation would pay the other half as payroll taxes. Since you have a net profit of $70,000 and half of that is your salary, you can take a profit distribution for the remaining $35,000 a year. You do not have to pay self-employment taxes for the distribution.
Deciding Between LLC vs S Corp
You have a big decision to make when you start your business. Should you become an LLC, Sole-Proprietor, or an S corp?
Sole-proprietorship is the easiest business to start, but you leave yourself personally exposed. It’s best to start your business as an LLC, even if you’re a single-member LLC.
You will need to establish separate bank accounts and paperwork, but you’re taxed the same as a sole-proprietorship. Should you elect to be taxed as an S corp? It depends on how much income you expect your business to generate.
It also depends on who you talk to. Some accountants say that it’s best to become an S corp once you hit $30,000 in net profits for the year. Others say that you should earn at least $50,000 gross before electing to be taxed as an S corp.
A reason for the disparity is the state laws around S corps. These laws vary widely from states to state and can place an administrative burden on your business.
One other factor is what you want to do with your business. If you are going to get venture funding and need more than 100 shareholders, an S corp isn’t possible. You’d have to file as a C-corp.
You should speak with at least one tax professional before you decide to be taxed as an S corp. This type of tax structure isn’t right for all businesses. You could wind up paying more in taxes and other costs for being an S corp and lose any financial advantage.
LLC vs S Corp: It’s a Tough Choice
You want to pay the least amount of money in taxes that’s legally possible. That largely depends on the corporate structure you set up when you start your business.
You can elect to be taxed as an S corp and be an LLC. Before you make a decision between an LLC vs S corp, be sure to speak with a few tax professionals to know if it’s right for your business.
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