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S corp vs LLC: How are they different, and how to choose?

Many states require that a registered agent be assigned to the S corporation. The agent should receive all legal documents and correspondence between state and federal agencies. Corporations typically must have appointed directors, officers, and board meetings.

If you do business in other states as an LLC, you’ll need to register to conduct business in each state, which will cost an additional foreign business registration fee. An S corp can only issue common stock, which gives voting rights to shareholders. An LLC cannot issue stock and does not have shareholders but must pay members according to the LLC’s articles of organization. If you decide to incorporate your LLC with S corp classification, you can’t issue stock. If you’ve been considering an S Corp for your venture or already have one in place, we encourage you to try our S Corporation tax calculator. It’ll factor in all relevant information to provide a range of insights from entity selection to benefit opportunities.

  1. Be sure to speak with a tax qualified professional already serving S Corps in your state.
  2. The IRS must receive the form within two and a half months of when you file your business formation documents with the appropriate state agency.
  3. If your business does qualify, electing S-corp taxation could limit who can own an interest in your LLC and how profits can be apportioned among owners.
  4. An S Corp tax calculator can assist you in estimating the amount of taxes you may owe if you choose to file as an S Corp.
  5. Net taxable income for an S corp is calculated by adjusting its gross income.

At that point, the S corp income is subject to federal, state, and FICA taxes based on the individual owner’s tax bracket and filing status. The S Corp election process involves completing IRS Form 2553, which requests the IRS to consider the entity as an S Corp for taxation. This form must be filed within 75 days of filing the business formation documents with the appropriate state agency. If not met within the time limit, the S corporation tax status will have to wait until the next year or file a request for late election relief with the IRS. It’s worth noting that electing an S Corp tax status involves compliance with more rigid rules and regulations—a critical consideration when deciding on the tax structure of a legal business entity. After electing S corp status, an LLC owner uses profits to pay salaries and distributions to owner-employees.

S Corporations elect to “pass through” income, deductions, credits, and losses to the owners of the business. This makes owners responsible for reporting taxable activity of the company on their personal income tax returns and allows the S Corp to avoid double taxation. Owners are also treated as employees and may draw a reasonable salary from the profits of the business. LLCs and S corporations (S-corps) are often talked about together, but they are not an either-or choice.

It is important to understand that the S corporation designation is merely a tax choice made to have your business taxed according to Subchapter S of Chapter 1 of the Internal Revenue Service Code. The choice of business entity is going to be primarily guided by the nature of the business and how the owner envisions the business unfolding and growing in the future. It’s important to note that the above list is not comprehensive since each state may have additional requirements. Once established, many states require LLCs to file an annual report for which the state may charge a fee. You may opt to have your LLC taxed as an S corporation by filing Form 2553 to be treated as an S corporation. “LLCs are a lot more flexible in terms of how you allocate the economics and amongst the owners, whereas corporations are more rigid,” Paris said.

Forming an LLC also gives business owners flexibility in running the business. One person can own your new LLC as a single-member LLC, or you can bring in multiple owners as a multi-member LLC. Forming an LLC also has fewer formalities and reporting requirements. An LLC is governed by your operating agreement, which lays out how you want your new business to function.

This is because all owners are required to receive “reasonable compensation,” which can significantly limit how much revenue is left for reinvestment. The paperwork is more straightforward, and the annual requirements are less complex, making it a popular choice for small businesses. If choosing S corp status is right for you, use Northwest to save you time in the long run.

How can I be sure my business is eligible for S-corp status?

Maximizing tax savings begins with building an efficient structure that makes the most of the tax code. Formations evaluates your business and creates the most tax-efficient structure for you. Try our S Corp tax savings calculator to see how this could impact your business. Setting a reasonable salary means paying yourself a wage that’s comparable to what someone else would earn for similar work in your industry and region. This tax pertains to salaries within your business, even if you’re self-employed.

Estimate your corporation’s taxes with Form 1120 or using the taxable income of last year. Consider additional taxes such as employment, payroll, self-employment tax, federal income tax, and accumulated earnings tax. Note differences between paying taxes for an S corporation and an LLC. The S corp income passes through to the owner’s individual tax return as salary and distributions. The owner’s salary pays employment taxes and income tax, while distributions only pay income tax at the shareholder level, which leads to S corp tax savings. An S corporation is not a separate type of business structure but rather a tax election made under Chapter S of the Internal Revenue Code.

How to Start an S Corp — Form 2553

S corporations have the liability protection of a corporation, but the S corp, itself, is generally not subject to regular federal income tax. Instead, like an LLC, most income and expenses of an S corporation are passed through to the shareholders. Limited liability companies are taxed differently from other corporations. An LLC allows pass-through taxation, which is when the business income or losses pass through the business and are instead recorded on the owner’s personal tax return. Historically, owners of S corporations have taken advantage of this tax benefit by classifying their income as zero percent salary and 100% distributions, thereby completely avoiding payroll taxes.

Forming an S Corporation

This means your tax liability isn’t just dependent on your income tax rate. Furthermore, lowering the reasonable wage benefits S corporation owners. Issuing yourself a lower W-2 wage decreases your employment tax while not impacting the overall profit your S Corporation makes. Since the greater portion of the profit isn’t subject to self-employment tax, this strategy results in substantial tax savings.

On the other hand, S corporations offer pass-through taxation, which allows corporate income, losses, deductions, and credits to flow through to the shareholder’s tax returns. Although the IRS charges minimal filing fees to elect S corp status, there are additional bookkeeping and payroll costs that can be expensive. Generally speaking, a reasonable salary plus $20,000 in annual distributions is often enough to save money on your tax return. In contrast, an S corp permits you to categorize part of your income as dividends or distributions. While the business still avoids corporate income taxes (similar to an LLC), the significant advantage is that income earmarked as dividends is exempt from both self-employment and payroll taxes. This allows small business owners to easily manage their business entity while also receiving the benefits of liability protection.

An LLC is more flexible than a corporation in organization and profit distribution. An LLC can also choose taxation as a corporation, and owners can save money by electing S corp tax status. Taxation is a key area where LLCs and S corporations differ significantly. By default, LLCs can be taxed as sole proprietorships or partnerships, depending on the number of members. This means that the LLC’s income is passed through to the owner’s tax return, and the owner is responsible for paying taxes on the profits at their tax rate.

Select an answer for each question below and we will calculate your S-corp tax savings

Selecting the right corporate entity will decrease your annual tax bill significantly. Being taxed as an S corporation is the simplest way for business owners to lower the amount of tax bills. Any profits, losses, or deductions that are business expenses that reduce taxable income quickbooks live bookkeeping are all reported on the owner’s tax return. An LLC with multiple owners would be taxed as a partnership, meaning each owner would report profits and losses on their personal tax return. For example, say you’re the sole owner of an LLC that made an annual profit of $100,000.

Always consider consulting a tax professional to identify the best fit for your specific situation. S corp status allows owners to classify a portion of their income as dividends, which are subject to neither self-employment nor FICA taxes. This can make S corps ideal for businesses that surpass a certain annual revenue threshold.

S corporation owners who work in the business are not “self-employed for tax purposes. Choosing the right taxation method will, therefore, depend on the size and scope of the company, the number of employees, the level of involvement of the owner(s), and tax considerations. First, your company must already be formed and registered with your state’s Office of the Secretary of State. Once you’ve received a certificate of incorporation showing that your business has been registered and incorporated, you must file form 2553 with the IRS. The form, called the Election by a Small Business Corporation, changes the company’s tax reporting status if the Internal Revenue Service approves it.

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