S-Corp vs. LLC: Tax Difference and Benefits (2023)

S Corp vs LLC: What's the Difference?

By default, a single-member limited liability company (LLC) is taxed like a sole proprietorship (i.e. the business owner reports income, gains or losses from the business on their personal tax return, also known as pass-through taxation), and a multi-member member LLC is taxed like taxing a partnership (not reported in the personal taxes of the business owner).

However, LLC holders can elect to be taxed as an S corp, which is a specific tax status under Subchapter S of the IRS Tax Act. In this way, entrepreneurs can often reduce their self-employment taxes, since shareholders can also declare income from the company in their personal tax returns. So the main difference is that in a single member LLC only the business owner can report the business profit/loss on their personal taxes while in an S corp all shareholders can.

When starting a small business, many entrepreneurs choose between two types of business entities – LLC vs. S-Corp. According to the National Small Business Association, about 30% of businessesare structured as S corporations and 37% of the companies are LLCs.[1]

There are detailed tax and structural differences between LLCs and S-Corps. Many small business owners seek the best of both worlds by registering their business as an LLC and choosing S corp tax status. This gives the business owner the legal and organizational advantages of an LLC, but the IRS treats the company as an S-Corp for tax purposes.

Here we explain more about the similarities and differences between S Corps and LLCs. We'll show you how to choose S Corp taxation and work through some examples of corporate structures that can save your business more money.

What is an LLC?

ACompany with limited liability(LLC) is a corporate structure recognized by all 50 states. In order to form an LLC, you must register and file your corporation with the statearticles of the organization, in a similar process asinclusion.

Once the LLC is formed, the owners, called members, receive certificates showing their interest in the company, much like stock certificates in a corporation. It is possible for an LLC to have multiple owners or a single owner. Although not required by law, most LLCs have an operating agreement that outlines each member's rights, responsibilities, and financial contributions. An LLC can bemanaged by members or managed by managers. In a manager-managed LLC, one of the members or someone appointed from outside the company makes the day-to-day business decisions.

LLC members enjoy limited liability, meaning they are not personally responsible for debts and obligations arising in the ordinary course of business. Compared to a corporation, LLCs typically have fewer record-keeping and reporting requirements. As we will explain in more detail below, LLCs also have a great deal of flexibility when it comes to taxation.

What is an S Corp?

There are two types of businesses that a business owner can start – oneS-Corp oder C-Corp. AC-Corporationis the traditional type and is subject to corporate income tax on corporate profits and personal income tax on dividends.

AS Corporationis a more restricted type of business. An S-Corp can have no more than 100 individual shareholders, all of whom must be US citizens or residents, and no more than one class of shares. S Corps offer pass-through taxation. This means that shareholders report corporate income and losses on their personal tax returns and pay their personal income tax rate on profits.

If you compareLLCs vs. Corporations, companies have more reporting requirements. However, a public company is the best business structure for companies hoping to raise money from investors as shares can easily be made available for money. Like LLCs, corporations offer their shareholders limited liability from corporate debt and lawsuits.

S-Corp vs. LLC: Tax Differences

While the two companies share pass-through taxation, there are some basic tax differences between an LLC and an S-Corp. Here's what you need to know about the tax differences between an LLC and an S Corp.

How are LLCs taxed by default?

If you form an LLC and do nothing else, the IRS will tax you under standard LLC tax treatment. By default, a single-member LLC is taxed as if it were oneone-man business. This means that the owner reports business income and losses on aSchedule Cand attaches it to his personal tax return. The GmbH does not have to submit a separate trade tax return.

By default, a multi-member LLC is taxed like a partnership. Each member of the LLC reports its share of the company's income, losses, credits and deductionsSchedule K-1(Form 1065). Each member is taxed on their share of corporate profits at their personal income tax rate.

In addition to business tax, members of an LLC must pay Taxes for self-employment on all company profits. Self-employed taxes cover Medicare and Social Security taxes for business owners. The current tax rate for the self-employed is 15.3%.

How are S Corps taxed?

At first glance, it may appear that an S-Corp is taxed just like an LLC. Each shareholder reports its share of the company's profits and losses in a Schedule K-1, and the profits are taxed at the shareholders' personal income tax rates. S-Corp files Form 1120-S with the IRS for informational purposes.

Of course, entrepreneurs cannot avoid self-employment taxes by just paying themselves through distributions. The IRS requires S Corp owners to pay themselves an appropriate salary given their job responsibilities and level of experience. For example, as the owner of an S Corp tech startup, you probably can't afford yourself a $10,000 annual salary. The IRS carefully reviews owners' pay levels, and companies that underestimate their pay could face oneIRS audit. If in doubt, you can go to websites such asglass doorandLohnskalto find good salary estimates.

LLC Taxed as an S Corp

Small business owners can choose to do thislegallyincorporate their business as an LLC but choose to fileSteeras an S Corporation. From a legal point of view, the company is a GmbH. You don't have to sell stock or comply with corporate reporting requirements. However, the company is an S-Corp to the IRS. For many companies, this is a win-win situation, allowing you to enjoy the legal and structural advantages of an LLC and the tax advantages of an S-Corp.

If you want to know how to get your LLC taxed as an S corp, you must file an applicationFormulate 2553with the IRS. For most corporations, the deadline for submitting the form is March 15 of the tax year in which the election is scheduled to take effect.

An LLC may be taxed as an S corp if:

  • The LLC is organized in the USA.
  • The LLC has no more than 100 members.
  • All members are US citizens or US residents.

Form 2553 can be downloaded from the IRS website. If you prefer further help, we recommend that you consult a tax advisor or business lawyer. Online legal services sites such asLegalZoomalso offer Form 2553 filing services.

S-Corp vs. LLC:tax benefits

One of the main benefits of taxing with an S-Corp is that it saves you money on self-employed taxes. In an S-Corp, a shareholder who actively works for the company is considered an employee and only his or her salary is subject to self-employment tax. Distributions outside of salary (also known as dividends) are not subject to self-employment tax. Additionally, S-Corps benefit from pass-through taxation.

Again, the biggest and most obvious benefit of an LLC is pass-through taxation, where all business losses and gains are accounted for on the business owner's personal tax returns and are not subject to the corporate tax returns that come with different tax brackets and rates.

S-Corp vs. LLC: Other Differences

Tax differences between LLCs and S-Corps are important, but there are other differences as well. These differences only apply if your company is structured as a corporation. If your company is organized as an LLC and you simply elect S corporation tax status, these differences will not apply to you.

  • Ownership and management structure:LLCs are owned by their members and the day-to-day decisions can be made by the members or a manager elected by the members. In contrast, corporations are owned by shareholders and managed on a daily basis by senior executives. A board of directors makes strategic decisions.
  • Recording obligations:Corporations have more mandatory reporting requirements than LLCs. For example, corporations must publish an annual report, issue share certificates, adopt articles of incorporation, and hold regular shareholder and directors' meetings. LLCs are required to file at most one annual report. And while it's recommended for LLCs to hold regular meetings, they don't have to.
  • transfer ownership:Typically, there are no restrictions on an S Corp shareholder selling their shares. However,LLC Operating Agreementsoften require the approval of other members before a member can sell their ownership interest in the company.
  • Profit and Loss Split:In an S-Corp, shareholders receive gains and losses according to the percentage of shares they own. However, with an LLC, the ownership interests do not have to match the division of profits and losses. For example, a member who owns only 40% of the company could receive 70% of the profits and losses.

S-Corp vs. LLC: Which Should You Choose?

Ultimately, there are many factors that influence your choice between an LLC or an S-Corp, but profitability should be one of the key factors. If your business has income left over after you've paid yourself a reasonable salary, you should consider choosing an S corp tax status. With the excess income, you can afford a distribution that is not subject to self-employment tax. This can save you thousands of dollars and increase your bottom line.

To make things clearer, let's look at an example of how much a company would pay under standard LLC tax status and as an S corp. First, let's assume that you are the sole owner of ABC Bakery LLC, which had net taxable income of $100,000 in 2020 after allowing for allowable business expenses. For the sake of simplicity, let's assume that you have no other income outside of business and that you are a single parent.

  • income tax:Under the 2020 tax brackets, you would pay a personal income tax rate of 24%, bringing your income tax bill to $24,000.
  • Taxes for the self-employed:They would also have to pay 15.3% self-employment tax on all company profits, which equals $15,300.
  • Total taxes:The total tax liability would be $39,300. (Note that this is the caseNotinclude payroll taxes you would have to pay for your employees, or state and local taxes.)

Now suppose you choose to have ABC Bakery taxed as an S-Corp. The business has a net taxable income of $100,000 from which you deduct $60,000 as a reasonable annual salary. You pay yourself the remaining $40,000 as a distribution. Here's how your taxes would affect:

  • income tax:Under the 2020 tax brackets, you would pay a personal income tax rate of 24%, bringing your income tax bill to $24,000.
  • Taxes for the self-employed:Only the $60,000 salary would be subject to self-employment tax at 15.3%, which is $9,180.
  • Total taxes:The total tax liability would be $33,180.

In this example, if you choose to be taxed as an S-Corp, you will pay less tax overall. However, this is only a viable option if you are able to split your company's total income into two parts - one for salary and one for payouts. Choosing S-Corp tax status also complicates your tax return, as you will need to set up a tax deduction (for your own pay and that of all employees).

The final result

When deciding on a corporate structure, LLC vs. S-Corp is an important decision you need to make.Many business owners choose to structure their businesses as an LLC for operational reasons, but then choose to be taxed as an S Corp. This could be a good solution if your business is already generating revenue. S Corp tax status can save you hundreds, even thousands, in taxes. As always, we recommend speaking with a tax professional to understand how choosing between an LLC or an S-Corp will affect your business specifically.

Article Sources:

  1. NSBA.biz. „Economic report for the first half of 2018
Top Articles
Latest Posts
Article information

Author: Sen. Emmett Berge

Last Updated: 11/18/2022

Views: 6019

Rating: 5 / 5 (60 voted)

Reviews: 91% of readers found this page helpful

Author information

Name: Sen. Emmett Berge

Birthday: 1993-06-17

Address: 787 Elvis Divide, Port Brice, OH 24507-6802

Phone: +9779049645255

Job: Senior Healthcare Specialist

Hobby: Cycling, Model building, Kitesurfing, Origami, Lapidary, Dance, Basketball

Introduction: My name is Sen. Emmett Berge, I am a funny, vast, charming, courageous, enthusiastic, jolly, famous person who loves writing and wants to share my knowledge and understanding with you.