The way you structure your business can be an important decision because it has legal and tax implications. It can determine the level of separation between you and your business, and how much you pay in taxes.
Two of the primary options business owners have when it comes to entity formation are an LLC or an S corporation. How do you know which one is correct for you not just in the present, but also what will work best for your business in the future?
The following are some things to consider when comparing an LLC and an S Corporation.
One of the biggest advantages and similarities between both an LLC and an S Corp is their element of limited liability protection. In both of these scenarios, a business owner isn’t personally responsibility for the liabilities and debts of the business.
If you are operating as a sole proprietor, on the other hand, you can be personally responsible for business debts, which depending on the situation can become incredibly damaging and devastating to an owner.
Another similarity between an LLC and an S Corp is something called pass-through taxation. Both are entities that are viewed as pass-through regarding taxes. There is a difference here, though. An S Corp is required to file a business tax return, but with an LLC a business tax return is only required for companies with more than one owner.
Pass-through taxation means taxes aren’t paid at the business level.
Any profit or loss from the business passes through to the owners personal returns.
With an LLC, the taxes are paid on the owner’s individual tax return, based on their percentage of ownership of the company.
With an S Corporation, the owner would be paid what would be deemed a reasonable salary, and then any profit or loss that’s left over goes through to the personal tax return of the owner.
Also important to note in terms of taxes is that LLC owners do have to pay self-employment tax on their income generated, so that can mean quarterly payments are due to the IRS.
S Corp Requirements
In general, creating an S Corp can be advantageous in a lot of ways, but it’s important for business owners to be prepared for the fact that it can be a more complex process than creating an LLC. Certain state and federal standards must be met, and it can also cost more to form an S Corp.
Even once the S Corp is formed, some requirements must be adhered to, such as passive income limitations.
S-Corps also have limitations on the number of owners a business may have, while LLCs can have any number of members.
As a final note to help understand the fundamental differences between an LLC and an S Corp, with an S Corp there are directors and officers that are part of a board overseeing the company.
These aren’t all the differences, but they do give a general overview that can help business owners get started with the process of entity formation.