Certified tax advisor @ S. Sharma Tax, Inc.
As a tax and business consultant, one of the most common questions I get is “Should I open an LLC or S corporation?” I wish there was a quick and easy answer to this question; however, there are many things to consider before jumping online and registering a company. First and foremost, I recommend doing thorough research or consulting with a legal and tax professional to determine which structure is best for your business. You will be surprised how many people consult with their friends and immediately decide to open a business.
When it comes to structuring a business, one of the most important decisions business owners make is deciding what kind of entity is best for their business. From my experience, LLCs and S Corporations are the most common. Both LLCs and S-corps provide liability protection for business owners, but they have different tax and organizational structures that can affect a company’s financial and legal status.
LLCs are a popular choice for small businesses because they offer personal asset protection while allowing for onward charging. This means that the company itself pays no tax on its income; instead, the gains and losses are passed on to the individual owners, who report them on their income tax returns. This eliminates the need for double taxation, which occurs when a C corporation pays taxes on its own income. Then shareholders pay taxes on the dividends they receive from the company.
S-corps, on the other hand, is a type of business that has chosen to be taxed under Subchapter S of the Internal Revenue Code. Like LLCs, S-corps also offer personal asset protection and chargeback. However, there are some key differences between the two structures. An important difference is that S-corps have stricter rules for ownership and management. S-corps can have up to 100 shareholders and must be resident entities, while LLCs can have unlimited members and be incorporated in any state. In addition, S-corps must have a board of directors and hold annual meetings, while LLCs have no such requirements.
One of the main advantages of S-corps over LLCs is that they allow more favorable tax treatment of income that is passed on to the owners. For example, owners of an S corp and LLC are required to pay taxes on the profits, whether distributed or not. Profits from an LLC are subject to self-employment tax (Social Security and Medicare). While S-corps profits are not subject to self-employment tax, this effectively results in savings of 15.3%.
In conclusion, the decision to form an LLC or an S corp depends on a company’s individual needs and goals. LLCs offer more flexibility in terms of management and ownership, but have restrictions on who can open them. For example, professionals who require a state license to practice their profession cannot be an LLC. Instead, they are required to operate a Professional Corporation, while S-corps offer more favorable tax treatment.
The information provided here is not investment, tax or financial advice. You should consult a licensed professional for advice on your specific situation.