LLC vs S Corp: Which is Best & Difference Between Them + Tax Benefits
Nobody likes paying taxes – the tax code is complicated, taxes can get expensive, and it can be hard to predict whether you’ll be getting a refund or if you’ll owe the government.
Thankfully, one aspect of the tax code can really help everyday people lower their tax burden. This aspect is the ability to start an LLC or S Corporation and get your income through that. The process is simple, and it can save you tens or even hundreds of thousands of dollars in tax liability.
What Are LLC’s and S Corps?
An LLC and S Corporation are special kinds of corporate entities. They are small businesses that have special eligibility restrictions and benefits. We’ll help you understand the similarities and differences between these two important concepts. We’ll also explain the benefits of using an LLC or S Corp for your situation so you can get the most out of your money.
The reason that you get so many benefits from starting an LLC or S Corp is that so much of the US economy is based on small businesses. That means the government has an incentive to promote these types of businesses.
As a result, the government has given these businesses advantageous tax statuses. These special statuses let you lower your tax liability by claiming the everyday expenses you make as business expenses.
The consequence of this setup is that you functionally pay for items with pre-tax money instead of post-tax money. That means you can stretch your dollars further and grow your wealth and net worth.
LLC and S Corp Similarities
Limited Liability Corporations and S Corporations have several things in common. We’ll cover those aspects here.
The first thing that an LLC and S Corp have in common is that they both provide liability protection. That means for the most part you will not be personally on the hook for business debts and liabilities. This can protect your personal assets if an unfortunate accident should happen.
Pass through Taxes
Another thing that S Corps and LLCs have in common is that they both have a system of pass-through taxes. That means you don’t get taxed twice on income. Normally, a business pays its own business taxes. The owners and employees of that business also pay taxes on their profits and wages. That means the money going through the business is being taxed twice.
However, with an S Corp or LLC you don’t get this double taxation. That means your money goes much farther than you might think.
The final major point that LLCs and S Corps have in common is that they both have some type of regulatory requirements they need to follow. These requirements are usually issued at the state level. That means you’ll want to check with your state to see if there are any special restrictions or requirements on your ability to form or benefit from an LLC or S Corp.
However, for the most part these regulations and restrictions are fairly lax and easy to meet. They usually involve paying an annual fee to maintain your corporate status.
LLC and S Corp Differences
There are some key differences between S Corps and LLCs though. These differences will help determine whether you would benefit most from an LLC or an S Corp. the differences include membership numbers, citizenship and residency requirements, and self-employment taxes.
The first key difference is membership numbers. An LLC can have any number of members, while an S Corp must have 100 or fewer shareholders. This isn’t going to be a big deal for the vast majority of people looking at this article, as most people will be forming a corporation where they’re the sole shareholder or their shareholders are limited to immediate family members.
The next difference between the two types of special corporate entities is citizenship and residency requirements. The difference is a simple one. LLC members and owners don’t have to be US citizens or residents. On the other hand, S Corp owners must be citizens or legal residents.
The final difference between LLCs and S Corps is also the most important. It has to do with self-employment taxes. With an LLC, you’ll need to pay self-employment taxes on the entirety of your income through the LLC. However, an S Corp can pay its shareholders a reasonable salary.
This reasonable salary comes in the standard format you get with any other W2 job. You get FICA taxes taken out with each paycheck, along with the other appropriate federal, state, and local taxes. You can also get corporate earnings in addition to your salary. This money is considered unearned income and isn’t subject to self-employment taxes.
Benefits of Using an LLC or S Corp
There are lots of benefits to using an LLC or an S Corp for your personal income. The main benefits are retirement bonuses, legal protection, passthrough taxes, and cheaper cost of living.
Self-employed individuals don’t have access to things like a 401k or Roth IRA that employers offer, as they are their own boss. However, they do have access to special retirement planning products that are, in a word, awesome.
The first type of product that limited liability companies get access to is a SEP IRA. This is a special type of IRA with a much higher contribution limit than a Roth IRA and is more flexible than a standard 401k.
You can contribute up to $53,000 per year to a SEP IRA. Compare that to the $5,500 limit for contributions to a Roth IRA. It’s nearly 10 times as much tax-free income. Moreover, you can deduct 100% of your contributions from your business’s earnings. That means these contributions come pre-tax.
Another benefit is that you can include other assets in your SEP IRA. One example is rental property. This is important because standard Roth IRAs and 401ks limit you to contributions out of your salary.
Additionally, you can still qualify for regular IRA’s. You can even set up a 401k through your company in most circumstances. Remember, this is a great addition because money that goes to these types of accounts is tax-deferred. That means you get to keep more of your salary for later.
The next major benefit of setting up an LLC or S Corp is that you get legal protections. Specifically, an LLC is solely responsible for its debts and obligations. That means your personal assets and wealth will be protected from debt collection efforts, lawsuits, judgements, and other similar situations.
Passthrough taxation is one of the most common benefits that inspire people to take advantage of LLCs and S Corps. This is especially the case with an LLC.
An LLC doesn’t have to file its own tax return. Instead, the LLC owner can report their portion of profits and losses on their individual tax return. That means you only pay taxes once, instead of the money being taxed at the business and the individual level.
With an LLC or S Corp you gain access to the ability to write of common expenses as business expenses. For example, a cell phone plan that you currently pay out of post-tax income could be paid from pre-tax income, lowering your tax burden and letting you save money.
An example can help illustrate this. If you’re paying for a $100 a month cell phone plan out of W-2 wages, then you need to make $125 to pay for the plan plus the taxes on your income. That means you’re functionally paying 25% more for all of your business-related expenses.
Moreover, depending on who the owners are, this can help save money on your everyday life in other ways. For example, if you own the business with your spouse, then date nights can qualify as a 50% deduction as long as you talk about the business a bit while you’re at dinner.
It’s easy to see how this situation can greatly benefit many individuals and families by lowering the cost of products and services by allowing people to pay for those things out of pre-tax dollars, rather than making them pay for it from post-tax money.
Losses can be Gains
Finally, when you incorporate you can even gain from your losses. That’s because initial losses when starting a business can count against your other tax obligations. This lowers your taxes overall. Moreover, depending on your losses and other aspects of your business, you can carryover losses from year to year, lowering your future tax burdens until the initial losses are recouped and your business is net-profitable over its lifespan.
Choosing Between an S Corp and an LLC – Which is Right for You?
Now that you understand the similarities and the differences between an S Corp and an LLC and have a good idea of the benefits of using these special corporate entities, you need to decide which option is best for you. We’ll cover the things you should consider when making this decision. We’ll also give some general advice about when an LLC is best for you and when an S Corp is best for you.
Things to Consider
This section contains the things you need to consider when you’re picking between an S Corp and an LLC. You should use this section to help you stack the pros and cons of each option to determine which is best for you.
The first consideration is paperwork. If we’re honest with ourselves then we have to admit sometimes there are people who aren’t the best with paperwork. An S Corp will require more paperwork because you need to pay yourself a salary and pay the respective payroll taxes on that salary. That means more time spent accounting and less time making money.
An S Corp also needs to file a separate tax return. This isn’t much more work because of the accounting requirements needed for payroll operations. However, it is still one more thing that needs done.
On the other hand, an LLC doesn’t require its own tax return. Instead, individual shareholders can report their portion of profits and losses from an LLC on their individual tax returns. As a result, there’s far less paperwork involved with maintaining and LLC than there is with an S Corp.
The next thing to consider is purely procedural. Specifically, if the owners of your corporation meet the requirements for citizenship and/or residency that the particular corporate structure requires. If you or another member of your business aren’t US citizens or permanent legal residents, then you’ll need to form an LLC instead of an S Corp.
Additionally, you need to determine how many people will be shareholders for your corporation. If you decide that you want to include more than 100 shareholders, than you can’t form an S Corp.
The final important consideration is how taxes work with each type of entity. While both an S Corp and an LLC enjoy passthrough tax status, the way that self-employment taxes work with each means that there are still important distinctions.
You will probably have a lower overall tax burden with an S Corp than you would with an LLC. That’s because the wages an S Corp pays are taxed normally. As a result, additional earnings from an S Corp don’t get hit by self-employment taxes.
On the other hand, this situation means that you’ll have to pay yourself a regular salary, take taxes out of that salary and pay the government. With an LLC, you can just report end of year profits and losses on your individual tax returns. This greatly simplifies the process, but it doesn’t expose you to the self-employment tax. As a result, your tax burden could be higher with an LLC than it would be with an S Corp.
How Much You’re Making
Because of the paperwork and tax structures of each option, there’s a certain amount of money you’re going to want to be making before you decide to set up an S Corp.
Generally, you only get the biggest advantages of an S Corp if you’re pulling in more than $100k per year. That’s because of the need to give yourself a reasonable salary in addition to the unearned income you take from profits in the business.
An LLC is Best for You If….
There are several reasons to prefer an LLC to an S Corp.
The first reason is if you are a very small operation. If your entire business is just you, then an LLC is just easier to keep up with. There’s less paperwork involved. There’s also fewer complications when it comes to expenses and taxes.
Another reason to prefer an LLC is if you’re making less than $100k per year. In this situation, the administrative hassle of an S Corp probably outweighs the benefits you get from things like exemption from self-employment taxes.
Finally, an LLC is the best option if your shareholders don’t meet the qualifications to be part of an S-Corp. This is the case if the business has more than 100 owners, or if they owners aren’t US citizens or permanent legal residents.
In summation, you should pick an LLC if:
- You make less than $100k per year
- You’re the sole owner and worker for your business
- You or other owners don’t meet the qualifications for an S Corp
- You’re not worried about self-employment taxes
- You lack the time, resources, or specialized knowledge to set up and maintain a payroll system with all its attendant taxes and issues.
An S Corp is Best for You if…
That being said, if you can, then an S Corp has more advantages than an LLC. Specifically, you get all the same benefits of an LLC while reducing your tax liability by avoiding self-employment taxes on corporate profits after payroll.
An S Corporation is the best option if you’re making $100k or more per year. That’s because you can pay yourself a reasonable salary and then take other corporate profits as unearned income. This dramatically lowers the tax burden you’ll face.
You should also prefer an S Corporation if you already have the ability to do and track payroll, and if all of your shareholders meet the residency and/or citizenship requirements.
To summarize, an S Corp is best if:
- All owners meet residency requirements
- You make more than $100k per year
- You can handle payroll obligations
- You want to reduce your tax liability as much as possible.
LLCs and S Corps – A Great Way to Save Money
No matter what choice is best for you, the facts make it clear that going with an LLC or an S Corp is far better than simply filing as an individual with no corporate status. This leaves your personal assets exposed to liability from debts and legal judgements while increasing the amount of taxes that you pay on your hard-earned money. As a result, incorporating is the best way to lower your tax burden and get the most out of your dollars.
You may be trying to decide on the best legal structure before getting a business loan for new business, or you’re trying to make your business more tax efficient, or you may be wondering how you can improve your current business structure. We get a ton of questions about LLCs and S Corps. The finer details of this subject are quite complex, and vary depending on the state that you live in. For this reason, it’s always a good idea to speak to a tax attorney before you make any permanent decisions.
Below are some of the top FAQs we receive from our readers.
Basic S Corp Vs. LLC FAQ
Here are FAQs about the basics of S Corps and LLCs.
Can an S Corp own an LLC?
Can an LLC be an S Corp?
What is the difference between LLC and S Corp?
What is a LLC S Corp?
Which is better LLC or S Corp?
Is an LLC an S or C Corp?
Can an LLC be taxed as an S Corp?
Can LLC elect S Corp status?
Can LLC file as S Corp?
Can an S Corp be a partner in an LLC?
What is the difference between sole proprietorship, LLC, S Corp?
What is the tax difference between LLC and S Corp?
When to switch from LLC to S Corp?
Methodology S Corp Vs. LLC FAQ
If you have questions about the methodology involved in S Corps and LLCs, this FAQ section may help you.
How to change LLC to S Corp?
How to change S Corp to LLC?
Can you change an S Corp to an LLC?
How to file LLC taxes as S Corp?
Other S Corp Vs. LLC Questions
If you have any other questions, you may be able to find them here.
Should I make my LLC an S Corp?
Why S Corp is better than LLC?
What is best LLC or S Corp?
Why LLC is better than S Corp?
How to elect S Corp status for LLC?
Is an LLC a partnership or S Corp?
Can an LLC file taxes as an S Corp?
Is an LLC and an S Corp the same thing?
Is an LLC a C Corp or S Corp?
Is LLC or S Corp better for small business?
Should I start an LLC or S Corp?
Which is better for taxes LLC or S Corp?
Are you still LLC after electing S Corp?
Can a California LLC elect to be an S-Corp?
Can a company be an LLC and an S-Corp?
Can a LLC own part of a subchapter S Corp?
Can a realtor be an S-Corp or LLC?
Can a subchapter S Corp own an LLC?
Can an accounting firm that is LLC use S-Corp election?
Can an LLC buy an S Corp?
Can an S Corp own an LLC interest?
Can an S Corp be managed by LLC?
Can I change LLC to S Corp at any time?
Can I put multiple LLC'S under 1 S Corp?
Can LLC taxes as S Corp retain earnings?
Yes. You are able to distribute your earnings as profits or retain them, regardless of whether you’re an S Corp. Also become familiar with terms such as operating working capital to successfully run your business.
Can you be both LLC and S-Corp?
Can you move a partnership LLC to a S Corp?
rtnership is not an LLC. You need to be an LLC if you would like to elect as an S Corp. You must first incorporate before you can elect as an S Corp.
Do you rename your LLC once it's a S Corp?
Jason is a Senior Author for SBL. He has been working with small business owners like you for the past ten years. He graduated with an MBA and began a career as an independent financial consultant for small businesses in his state.