Joey Bada$$ Weighs In: LLC vs. S Corp Explained
Inspired by Joey Bada$$’s character on Mr. Robot, you may be wondering if your business should operate as an LLC or take the S Corporation tax route. While the terms “LLC” and “S Corp” are often used interchangeably, they serve very different purposes in the business world. Understanding these distinctions—and how they can work together—could save you time, money, and unnecessary headaches.
In this blog, we’ll break down what an LLC is, what an S Corporation is, and how your LLC can elect to be taxed as an S Corp for maximum benefits.
LLC: What Is It and Why Choose It?
An LLC (Limited Liability Company) is a business entity formed at the state level. It provides:
Liability Protection: Members’ (owners’) personal assets are generally protected from business liabilities.
Flexibility in Management: LLCs can be member-managed or manager-managed.
Simple Formation: Filing Articles of Organization with your state is typically straightforward.
Key Tax Features of an LLC:
Default Taxation:
Single-member LLCs are taxed as sole proprietorships (disregarded entities).
Multi-member LLCs are taxed as partnerships.
Pass-Through Taxation: Profits are reported on the members’ personal tax returns, avoiding corporate-level taxes.
S Corporation: What Is It and How Does It Work?
An S Corporation is not a business entity but a federal tax election that an LLC or corporation can choose by filing Form 2553 with the IRS. This election changes how your business income is taxed, offering potential tax savings.
Key Features of an S Corporation Tax Election:
Pass-Through Taxation: Like an LLC, profits and losses pass through to the owners’ personal tax returns.
Tax Savings on Self-Employment Taxes:
S Corp owners who are active in the business pay themselves a “reasonable salary.”
Only the salary is subject to self-employment taxes (Social Security and Medicare).
Remaining profits, paid as distributions, are not subject to self-employment taxes.
Can an LLC Be an S Corp?
Yes! An LLC can elect to be taxed as an S Corporation while maintaining the legal protections and flexibility of an LLC. This combination provides the best of both worlds for many small businesses.
Steps to Elect S Corporation Status for an LLC:
Form Your LLC: File your Articles of Organization with your state.
File IRS Form 2553: Elect S Corporation tax treatment. This must typically be done within 75 days of forming your LLC or at the beginning of the tax year.
Pay Yourself a Salary: If you’re actively involved in the business, pay yourself a reasonable salary to comply with IRS rules.
When Should You Elect S Corp Tax Status?
Electing S Corp tax status isn’t always the best option. Here’s when it makes sense:
Advantages of S Corp Taxation:
Tax Savings: For businesses with significant profits, paying a reasonable salary and taking the rest as distributions can reduce self-employment taxes.
Pass-Through Taxation: Avoids the double taxation faced by C Corporations.
Disadvantages of S Corp Taxation:
Payroll Requirements: You must run payroll and withhold taxes for your salary.
Administrative Complexity: Filing payroll tax forms and maintaining compliance require additional effort.
Not Ideal for Low Profits: If your business isn’t earning enough to justify a salary and distributions, the additional complexity may outweigh the tax benefits.
Pro Tip: Many business owners stick with default LLC taxation in the early stages of their business and elect S Corp status as profits grow.
Next Steps for Your Business
Choosing the right structure for your business is a critical decision that impacts your taxes, liability, and future growth. Whether you’re starting fresh or looking to optimize your tax strategy, we can help.
At our offices in Detroit, Dearborn, and Royal Oak, we assist businesses across Southeast Michigan in forming LLCs, making S Corp elections, and building comprehensive business plans.