An S Corp is not a type of business but the way the business chooses to be taxed. Sole proprietorships, partnerships and multimember partnerships are automatically considered limited liability corporations (LLC) by the Internal Revenue Service. The LLC, however, can choose to be taxed as a C Corp or as an S Corp.
Both LLCs and S Corps are considered “pass-through” tax entities and must file business tax returns. An LLC only has to file a tax return if it has more than one owner. Both do not have to pay taxes on the business level. Tax on the profit is paid on the owner’s personal tax return. In an S Corp, the owner pays themselves a salary plus receives dividends from additional profits the corporation may earn. In an LLC all income and expenses get reported on the owner’s personal tax return. Both LLCs an S Corps can deduct business expenses such as office equipment and advertising.
An S Corp offers tax advantages when it comes to profit distributions. The owner is paid a reasonable salary (tied to industry norms), while also deducting federal taxes and FICA. Any remaining profits from the company can be distributed to the owner as dividends which are taxed at a much lower rate than income.
The advantages of an LLC, on the other hand, are that it is cheaper and easier to set up. You can elect to be taxed as an S Corp while retaining the structure of an LLC. Payroll must include salary with FICA deductions, etc (“self-employment tax”) and then you pay yourself a monthly dividend from the profits.
Remember, you must pay yourself a REASONABLE SALARY based on industry norms for your job. Your business can’t make $500,000, while you have a “salary” of just $25,000 for the year.
While an S Corp does offer tax savings, there is more paperwork involved with an S Corp and more requirements. You are required to hold meetings, keep minutes, make resolutions, elect officers and produce formal financial statements.
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