S Corp vs LLCThe S corporation is a tax status that as a business owner you can elect for your limited liability company (LLC) or a corporation. You have to form an LLC or a corporation (or already have an LLC or a corporation) to elect S corporation status. Show
A limited liability company (LLC) is a type of legal business entity that offers limited liability protection. When a business isn't structured as a legal business entity, it's called a sole proprietorship or partnership.
An LLC can choose to be taxed as an S corporation under Subchapter S of the IRS Internal Revenue Code. As an S corporation, LLC owners are taxed as employees of the company. The Difference Between an LLC and an S CorpThe difference between running a business as a normal LLC vs S corp is that S corp status allows business owners to be taxed as employees of the business (instead of paying self-employment taxes as a normal LLC, sole proprietorship, or partnership). S Corp vs LLC TaxesAn LLC can be taxed as a default LLC or as an S corporation. Default LLC TaxesWhen an LLC's net profit and/or distributions pass through to the owner's individual tax return, it is subject to income taxes and self-employment payroll taxes (full FICA and Medicare). This is what happens in the "default" scenario for an LLC. S Corp TaxesElecting S corp status allows business owners to be treated as employees of the business. In an S corp, the business must pay the owner "reasonable compensation" or "reasonable salary" per IRS guidelines. The owner pays income taxes and payroll taxes (FICA and Medicare) on their salary. Distributions are only subject to income taxes (no FICA). In a default LLC, the owner would pay income taxes and full self-employment FICA and Medicare taxes on their percentage of net profit and any distributions or draws from the LLC.
The business might need to spend more on accounting, bookkeeping, and payroll services. To offset these costs, a business owner would need to be saving about $2,000 per year on taxes. When To Elect S Corporation StatusWe estimate that if business owners can pay themselves a reasonable salary and at least $10,000 in annual distributions, they could benefit from S corp status. $10,000 in annual distributions is the estimated amount that would create enough tax savings to offset estimated additional accounting, bookkeeping, and payroll costs that can arise when you run an S corporation. You can start an S corp with our guide or use an LLC formation to do the work for you. Save yourself the hassle and let Northwest start your S corporation for you. S Corp vs. LLC CalculatorUse our S Corp vs. LLC Calculator to estimate whether electing S corp tax status makes sense. S Corp Savings CalculatorCalculate how much you can save by choosing an S Corp tax classification LLC Net Income before salary Reasonable Salary S Corp Benefits and RequirementsThe following criteria determine whether electing the S corp tax
classification makes sense for an LLC:
Reasonable SalaryUnder an S corp election, LLC owners become employees. The IRS requires owner-employees to be paid a reasonable salary, referred to by the IRS as "reasonable compensation." A reasonable salary is any salary that you would pay someone to do the same job. LLCs taxed as S corps are subject to increased scrutiny by the IRS. If the owner is not paid a reasonable salary, this may lead to the IRS denying S corp status and may lead to fines and back taxes. To determine a reasonable salary for your position, you can compare similar salaries on websites like Glassdoor or the US Bureau of Labor Statistics. Profit and DistributionS corp election allows a business owner to disburse an LLC's profit to owner-employees in the form of salary and distributions. The IRS then applies FICA and income taxes to only the salary. Distributions are subject to only income tax. If the LLC doesn't earn enough profit to cover a reasonable salary and distribution, it won't make financial sense to elect the S corp tax classification. And, if the LLC owner(s) would like to forfeit salary for any reason, they could be subject to fines by the IRS. Positive Return on InvestmentIt costs money to elect and maintain an S corp. Filing fees with the IRS are minimal but the additional bookkeeping and payroll costs are not. For LLCs that already have employees and payroll costs, this factor won't hold as much weight. Business owners should weigh the cost of maintaining these services against the fiscal tax advantage of electing the S corp classification. Generally speaking, a reasonable salary plus $10,000 in annual distributions is often enough to make electing the S corp financially viable. IRS S Corp RequirementsThe IRS requires that businesses that elect the S corp status have 100 shareholders or less and they are only allowed to issue one class of stock. The owners of the business must be US citizens or permanent resident aliens. Owners must also be private individuals and not business entities such as LLCs, corporations, or trusts. For detailed, step-by-step instructions for starting an S corp in your state, choose your state from below:
LLC vs. S Corp: When to Choose LLC Default StatusMany LLCs will benefit most from the default LLC tax classification. LLC owners often put any profit back into their small businesses each year to promote growth. And without substantial distributions, there's no basis for electing the S corp tax status.
The default LLC tax structure is best suited for businesses with these characteristics:
Reinvesting LLC Profit and Pass-Through TaxationIf you expect to reinvest most of the profit back into your small business, default LLC status is the right choice. Small businesses usually have a low amount of net profit in any given year. This is because small businesses usually spend most of their income on expenses like marketing, software, and office equipment to help the business grow. Some owners also want the choice to not pay themselves and that's not possible with an S corp classification. Pass-Through Taxation When LLC owners choose to reinvest profit, very little net income (profit minus expenses) from the business will pass through to the LLC member(s) individual tax returns. You can visit our LLC Pass-Through Taxation guide to learn more about how default LLCs are taxed. Return on InvestmentFor some LLCs, the cost of hiring a payroll service and bookkeeper would outweigh the financial tax advantages of electing S corp tax classification. These LLCs would be best to operate as a default LLC. For step-by-step instructions for starting an LLC, choose your state from the list below:
You can also use an LLC formation service to register your LLC for you. Should Your LLC Elect S Corp Classification?Whether or not an LLC should elect S corp status depends on how much profit the business is going to earn and carry over from tax year to tax year. Generally, if you know your business is going to have an annual distribution that is greater than $10,000 after paying yourself a reasonable salary, then your business has enough profit to justify becoming an S corp. If you are unsure how much profit the LLC will make or if you want to reinvest the profits back into your LLC, it’s best to remain in the default LLC classification with the IRS. You can apply for an S corp status when it better suits your business. To elect to become an S corp, file Form 2553 with the IRS. Visit our instructions for Form 2553 page for help with completing the form. Ready to start your business today? Use a professional service to form your LLC or start your S corp, so you can focus on the things that matter most. |
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