If you’ve had your head down and nose to the grindstone, preparing to launch a business, it’s understandable if you don’t understand the ins and outs of corporate entities. But filing the right paperwork and making the right choices for your business can make a big difference in the taxes you pay and the way profits are distributed.
Choosing among business entities can be confusing. A tax attorney can eliminate the guesswork by explaining the options and steering you toward the corporate structure that best aligns with your business goals.
Important Nuances: S-Corp vs. LLC
There are many possible permutations for business entities. The one you choose for your business should have the right legal protection and tax benefits for your business. Your articles of organization, filed with the secretary of state, initiate the process while an operating agreement outlines internal management details.
There are a few key things to know about each:
- A limited liability company (LLC) offers the benefit of protecting the owners from losing personal assets if the company is sued by creditors. A single-member LLC is a sole proprietorship and a multi-member LLC is a partnership unless the owners opt for the tax structure of either a C-corporation or an S-corporation. If there are more than 100 owners or if owners/shareholders are not Americans, the company is not eligible for S- corp status. Few opt for C-corp status as it results in principals being taxed twice, once at the corporate level and again when profits are distributed to shareholders.
- An S-corporation is a tax classification that is often confused with a business entity. By opting for your LLC to be classified as an S-corp, the owners avoid being taxed twice for their assets and for self-employment tax on the owner’s income. Profits are passed through to the shareholders, who claim them as income on their taxes. In Illinois, the S-corp election must be made to the secretary of state’s office as well as to the IRS.
- Management of an LLC offers more flexibility to owners, allowing members to be managers. This makes them easier and less expensive to maintain. In contrast, management of an S-corp is more strict, requiring a board of directors and corporate officers, shareholder meetings and other formalities. These structural requirements can increase administrative costs.
- Tax benefits: differ significantly. An LLC typically pays over 15 percent self employment tax on all net earnings. By electing S-corp tax status, FICA is only paid on the owner’s salary, and the remaining profit is categorized as distributions not subject to self-employment tax.
- Profit allocation: In an LLC, profits and losses are designated in any percentage desired, but in an S-corp they are based on an individual’s ownership interest.
- Ownership transferability, if you want to eventually sell the business, is easier with an S-corp, as only the IRS must be satisfied, but an LLC requires agreement of all members.
Making the Right Choices for Your Business
It should be clear that an LLC and an S-corp are not an “either/or” choice, but two options in a range of choices that you can use to structure your business and keep taxes in check. Seeking guidance from someone who knows the corporate tax landscape is essential to getting started on the right foot.
Selecting a business entity that suits your needs now and in the future is a crucial component of profitability and growth. Bring all of your questions to a consultation with Legacy & Life Law Firm LLC business and tax experts for the clarity and confidence you need for long-term success.