The two most common business entities for a new business are an LLC (Limited Liability Company) and an S Corporation (a corporation with 100 or less shareholders).
LLC vs S Corporation
There are some key similarities and differences between the two, but often because of how financial professionals and lawyers talk about the two it becomes murky. So, here is a very clear and concise list of what makes them different so you can make an informed decision on what is best for you.
Liability Protection. Business owners are generally not personally responsible for business debts and liabilities unless the business owner uses business accounts for personal expenses on a regular basis.
Separate Entity. LLCs and S Corporations are separate legal entities created by filing papers with the state. Both require initial filings as well as annual filings to keep the business in good standing.
Taxes. Both are generally pass-through tax entities, but S corporations must file a business tax return. An LLC must only file a business tax return if there is more than one owner. Additionally, LLCs can elect to be treated as an S corporation for tax purposes.
Members. LLCs can have any number of members. S corporations must have 100 or fewer shareholders.
Citizenship/Residency. Anyone can be a member of an LLC regardless of citizenship or residency. S Corporations shareholders must be citizens or resident aliens.
Taxes. S Corporations have more advantageous self-employment taxes than LLCs. S Corp owners can be considered employees and paid “a reasonable salary.” FICA taxes are taken out and paid on the amount of the salary. Corporate earnings after salary may be able to be treated as unearned income that will not be subject to self-employment taxes.
What are the Benefits of an S Corporation
The S Corporation is the clear winner when it comes to tax treatment. The self-employment taxes are the biggest benefit to having an S Corp over an LLC. However, since an LLC is so much simpler, most new business owners start there. With the exception of a business whose sole income is directly tied to your hours like consulting, you can convert your LLC to an S Corp and get those tax benefits, and it would only really make sense to convert to an S-Corp once you’re earning a meaningful amount of money, probably over $100k.
By paying yourself a “reasonable salary,” you can take all the income above that reasonable salary as a distribution saving yourself social security and Medicare taxes effectively saving yourself a little over 15%. There is a fair amount of debate as to what a “reasonable salary” is. However, many people seem to use websites such as Glassdoor to gauge what appears to be reasonable for the industry.
If you still aren’t sure what is best for you and your business, call Hammelman Law, PLLC. Melanie handles business law and estate planning in Northern Virginia and Maryland. As the owner of a small business herself, Melanie is able to assist both new business owners in forming their companies and ensuring that all the necessary filings are completed. Melanie is also able to assist both new and experienced owners with all the necessary contracts for their businesses, all at affordable rates.