S-Corp vs. LLC

Both entities are “Pass-Through” entities for tax purposes; the income of these companies are passed through to their owners and reported on the owners’ personal income tax returns, thereby eliminating the double taxation incurred by owners of a standard corporation. Also both entities provide liability protection; this means that the owner of a company cannot be held personally responsible for the company’s debts. The personal assets of an owner are shielded from company liabilities.  So what are the differences?

Practical differences

Start- Up and formation costs ( Favors S-Corp) – Prices do not including legal fees to perform formation

  1. LLC:  New York  filing and formation Costs
    1. Reservation of name: $20
    2. Articles of Organization: $200
    3. Publication ( required in NY): $400-$1,600
    4. Certificate of publication: $50
    5. TOTAL = $670-$1870
  2. S-Corp:New York  filing and formation Costs
    1. Reservation of name: $20
    2. Articles of incorporation: $125
    3. S-Corp Election: $75
    4. Total = $220

Business Ownership & Operation (favors LLC)

  1. An S corporation can have no more than 75 shareholders, none of the shareholders can be nonresident aliens, and shareholders cannot be other corporations or LLCs. There are no restrictions on the ownership of an LLC
  2. An S corp. must follow the same formalities and record keeping procedures as a traditional Corporation. If the S-Corp has more than one shareholder, it must hold annual meetings, prepare meeting minutes, and document corporate actions. S-Corp’s must file and pay payroll tax throughout the year on wages paid to owner/shareholders. No such requirements apply to LLC’s.
  3. The S corp has no flexibility in how profits are split up among its owners. The profits must be distributed according to the ratio of stock ownership, even if the owners may otherwise feel it is more equitable to distribute the profits differently. The owners of an LLC can distribute profits in the manner they see fit.
    1. For example: you and a partner own an LLC. Your partner contributed $80,000 for capital and you contributed $20,000, but you perform 90% of the work. The two of you decide that, in the interest of fairness, you will each share the profits 50/50. As an LLC you could do that; with an S corporation, however, you could only take 20% of the profits while your partner would take the other 80%.

Employment Tax: Savings vs. Paperwork (Favors S-Corp)

  1. A major factor that differentiates an S corporation from an LLC is the employment tax that is paid on earnings. The owner of an LLC is considered to be self-employed and, as such, must pay a “self-employment tax” of 15.3% which goes toward social security and Medicare. The entire net income of the business is subject to self-employment tax. In an S corporation, only the salary paid to the employee-owner is subject to employment tax. The remaining “profit” that is paid as a distribution is not subject to employment tax under IRS rules. Therefore, there is the potential to realize substantial employment tax savings
    1. For Example: Let’s say you own a carpentry company, which earns ( after expenses) $75,000 . If you were an LLC the entire profit would be subject to self employment tax ( $75,000 x 15.3% = $11,475). However, if you were an S-corp, or an LLC electing to be treated as an S-Corp, you pay yourself a reasonable salary (according to industry guidelines) for a carpenter, which may be $40,000, and you take the remaining portion as a profit. Your total earnings for the year still are $75,000, but you have $40,000 paid in salary and the remaining $35,000 paid as a distribution from the S corp. Your total employment tax is $6,120 (15.3% of $40,000). Your total savings is $5,355.
    2. Caution: One might assume that these savings could be further manipulated by reducing the salary to an extremely low amount and attributing the rest of one’s earnings to distributions—but this would be an incorrect assumption. In practice, the IRS is careful to notice whether a salary is reasonable by industry standards. If it determines a salary to be unreasonable, the IRS will not hesitate to reclassify distributions as salary.
  2. While the potential employment tax savings may make the S corporation an attractive structure for your business, bear in mind that you would then have to deal with all the paperwork associated with payroll tax. The payroll tax is a pay-as-you-go tax that must be paid to the IRS regularly throughout the year–on time, or you will incur interest and penalties. In addition, an S-Corp requires a separate tax return so you will have to include the cost of preparing two returns ( one person and one corporate) a single member LLC can be filed on your schedule C of your individual tax return.
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