LLC vs S-corp: How to Choose the Right Structure for Your Business

Choosing a business structure can seem overly complicated & confusing, as the names are often similar with very different meanings and implications, leading to often even creating additional filings with no tax benefit. I wanted to touch on LLC & S-corporations and help provide clarity on their differences, as these are both common structures for small and mid-sized service businesses. While they do share some similarities, they are treated very differently for tax purposes.

Understanding the Difference Between an LLC and an S Corporation

An LLC is a legal structure that provides liability protection and flexibility. By default, a single-member LLC is taxed as a sole proprietorship, while a multi-member LLC is taxed as a partnership. Income passes through to the owner’s personal tax return. As a reminder, when you have a multi-member LLC, in most cases, you are also creating an additional tax filing requirement of a partnership return.

An S corporation is actually not a legal entity type, but a tax election made with the IRS. An eligible LLC or corporation can make an election to be taxed as an S corporation as a way to reduce self-employment taxes. 

LLC income is generally subject to self-employment taxes, whereas with an S corporation, owners instead opt in to pay themselves a reasonable salary (subject to payroll taxes) while taking remaining profits as distributions, which are not subject to self-employment tax.

LLCs are typically more simple to manage, with fewer formal requirements. S corporations require payroll processing, reasonable compensation analysis, additional tax filings, and do also have stricter compliance standards.

S corporations are often beneficial once a business reaches consistent profitability. Below certain income levels, the tax savings may not outweigh the added administrative costs.

Key Factors to Consider Before Making a Decision

Choosing the best type is not something that is easy to do. Every situation is different but some key factors that will play a role in choosing that should be considered are: 

• Annual net income (your gross revenue minus expenses)
• Long-term growth goals
• Cash flow needs
• Industry-specific considerations
• Owner involvement and compensation strategy
• Location: every state is different & some will tax you as an S-corp in a way that will not outweigh the benefit of not having self employment tax 

Making the wrong choice, or waiting to make a change, can result in unnecessary tax liability and/or compliance issues

Ready for Personalized Guidance?

If you are a service-based business owner or creative unsure whether your current structure is supporting your financial goals, I am currently accepting applications for tax advisory services. Apply to work with me to receive personalized guidance, proactive tax planning, and support designed around your business.