Comparing LLCs to S-Corporations
Y 2021 Issue 2 |
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our business is probably set up as a Limited Liability Company (LLC), an S-Corporation or both. But what’s the difference, and under what circumstances would it make sense to change your LLC into an S-Corporation? An LLC is a type of business entity (as compared to a sole proprietorship or corporation), while an S-Corporation is a tax election. An LLC is set up at the state level, while an S-Corporation election is made with the IRS at the federal level (and filed with your state’s secretary of state). Owners in an LLC are called “members,” while S-Corporation owners are called “shareholders.” Both LLCs and S-Corporations protect your personal assets from business creditors, unlike a sole proprietorship. That means business losses are limited to the amount of your investment in the business. It’s important to keep your personal and business financial affairs completely separate to maintain the corporate veil and not run the risk of losing that protection for your personal financial situation.
by Stacy Smith
Taxation of Business Income
Business income in an LLC flows to the members to be taxed at their personal rate. Owners are responsible for paying their own self-employment taxes (both the employer and employee sides of FICA and Medicare, a total of 15.3% of income). Taxable business income is reported on Schedule C of each member’s personal tax return. The LLC members need to make quarterly estimated tax payments to keep up with anticipated tax liability throughout the year. In contrast, S-Corporation shareholders take a salary, and like other employees, pay 7.65% in payroll taxes with the business paying the other half. The business can then take a tax deduction for the payroll tax expense. Any additional business profits are distributed to S-Corporation shareholders as dividends, which are not subject to payroll taxes. These dividends are allocated in proportion to each shareholder’s interest in the S-Corporation. S-Corporations file a separate tax return for the business using Form 1120-S.
