Choosing the Right Business Entity: LLC vs S-Corp
One of the most important decisions you'll make for your business is choosing the right entity structure. The difference between an LLC and S-Corp can save (or cost) you thousands in taxes annually.
Important Note
An S-Corp is not a business entity—it's a tax election. You can form an LLC or Corporation and then elect S-Corp tax treatment. Most small businesses comparing "LLC vs S-Corp" are really comparing an LLC taxed as a sole proprietorship/partnership vs an LLC taxed as an S-Corp.
LLC (Limited Liability Company)
How It Works
An LLC provides liability protection (personal assets protected from business debts) while maintaining flexible management and simple tax treatment. By default, single-member LLCs are taxed as sole proprietorships, and multi-member LLCs as partnerships.
Advantages
- • Simple to form and maintain
- • Flexible profit distribution
- • No corporate formalities required
- • Pass-through taxation (profits taxed once)
- • Can choose tax treatment
Disadvantages
- • All profits subject to self-employment tax (15.3%)
- • Harder to raise capital from investors
- • Some states charge high LLC fees
- • Limited life in some states
S-Corp (S Corporation Tax Election)
How It Works
An S-Corp is a tax classification that allows business profits to pass through to owners' personal tax returns while enabling owners to split income into salary (subject to payroll taxes) and distributions (not subject to self-employment tax).
Advantages
- • Significant self-employment tax savings
- • Pass-through taxation
- • Increased credibility with clients
- • Easy transfer of ownership
- • Unlimited life span
Disadvantages
- • More complex bookkeeping requirements
- • Must run payroll (even for owner)
- • IRS scrutiny on salary vs distributions
- • Strict ownership restrictions
- • Higher accounting costs
The Tax Savings: A Real Example
Scenario: Business profit of $100,000
Annual Tax Savings with S-Corp: $4,950
This is a simplified example. Actual savings vary based on individual circumstances.
When to Choose LLC
An LLC (with default taxation) works best when:
- Your business profit is under $60,000 annually
- You want the simplest structure with lowest costs
- You're a real estate investor (special tax benefits)
- You have multiple owners with complex profit-sharing
- You want flexibility to change structure later
When to Choose S-Corp
S-Corp taxation makes sense when:
- Your business profit exceeds $60,000 annually
- The tax savings outweigh additional accounting costs ($2,000-$3,000/year)
- You can pay yourself a "reasonable salary" and still have profits left for distributions
- You're okay with running payroll and more complex bookkeeping
- You meet S-Corp requirements (US citizen/resident, fewer than 100 shareholders, etc.)
The "Reasonable Salary" Requirement
The IRS requires S-Corp owners to pay themselves a "reasonable salary" for work performed. You can't pay yourself $1 and take the rest as distributions to avoid payroll taxes.
Warning:
The IRS audits S-Corps specifically for unreasonably low salaries. Work with a CPA to determine an appropriate salary based on industry standards, your role, and business profitability.
Can You Switch Later?
Yes! You can form an LLC and later elect S-Corp taxation when your profit justifies it. Many businesses start as LLCs and convert to S-Corp treatment once they're consistently profitable. This gives you time to establish the business without the complexity of S-Corp requirements.
Not Sure Which Structure is Right for You?
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