LLC vs. S Corp Taxes: What Are the Benefits of Each?

You're an entrepreneur starting your own business and want to do everything possible to set your company up for success. You need to decide how best to structure your business and how you will handle your tax liability as a business owner. 

There's a lot of information, but it's hard to figure out how it fits together. Two terms you may hear a lot are LLCs and S Corps. What are they, and what do they mean for small businesses like yours? How will LLC vs. S Corp taxes work differently for your company? 

An LLC is a legal entity, while an S Corp is a tax classification. They overlap in various ways, and you could even use both statuses if it works well for your growing business. 

What Is an LLC, and How Is It Taxed?

An LLC is a business entity known as a limited liability company. It is an organizational structure that offers the liability protection of a separate business entity but with flexibility and control that corporations can't usually have. 

LLC status as a business structure is organized at the state level, so each state government has its process you can use to form an LLC. However, the federal government has no set regulations for taxing your LLC. As a result, you can elect to be taxed as a corporation, a sole proprietorship, or a partnership on your federal return.

For a single-member LLC, where you are the sole member and owner of an LLC running the business, the most common option is to be taxed as a sole proprietorship. That means you are taxed at the federal level as if the business is not separate from you as an individual. You report all your business income and pay taxes on your personal tax return. 

What Is an S Corp, and How Is It Taxed? 

At a glance, an S corporation functions similarly to an LLC, giving small business owners protection for their personal assets without sacrificing flexibility. So what’s the difference between an LLC and an S Corp? 

The critical difference is that while an LLC is an entity recognized only officially at the state level, an S Corp is a federal-level tax status. An S Corp is also a corporation, meaning it can issue stock. 

Any corporation that complies with certain limitations can get S Corp status with the IRS if they file form 2553, Election by a Small Business Corporation. Some states also have policies for recognizing S corporations. 

Like LLCs, S corporations are not taxed directly. They must file an informational tax return form 1120-S to report their income, and then owners can pay and file for their personal shares of that income on their own individual tax returns.

What Are the Tax Benefits of an LLC vs. S Corp?

It’s difficult to compare the benefits of an LLC vs. an S Corp because many of those tax benefits overlap. An LLC could even file as an S Corp for their federal tax return, which is not mutually exclusive. 

One of the most significant benefits of either is the ability to use pass-through taxation. This means that business income passes through to the owner so that business owners file company profits directly on their personal tax returns.  

S Corp status can also help you save money if you’re subject to self-employment tax. Usually, sole proprietorships and single-member LLCs must pay an additional self-employment tax on top of their FICA and Social Security taxes. S corporations, however, can allow you to avoid the extra taxes on additional business profits beyond a reasonable income amount. 

What Are the Tax Disadvantages of an LLC and S Corp?

LLCs and S Corps provide a lot of asset protection for small business owners, but they're a lot more work to organize than simply running a sole proprietorship. A lot of paperwork is required to keep your business in compliance and maintain your LLC or S Corp status with the relevant authorities. 

What Are the Disadvantages of an LLC?

While a limited liability company is a flexible business structure, it does include more regular fees and government oversight than a sole proprietorship. They must run according to the operating agreement established as their foundation. 

Members of an LLC are also generally considered to be self-employed business owners. This means that, while business profits will pass through the business directly to personal tax returns, members will then have to pay self-employment taxes, which means a 15.3% tax on income for Medicaid and Social Security.   

What Are the Disadvantages of an S Corp? 

For your business entity to qualify for S Corp status, it must comply with several requirements: 

Must be a fully compliant corporation in the United States

Shareholders must be legal U.S. residents or certain kinds of trusts and estates

Must have no more than 100 shareholders

Can only issue one class of stock 

Outside these requirements, the main disadvantage of an S Corp is simply the amount of paperwork required to file and maintain special tax status. Corporations are more highly scrutinized than other businesses and must provide detailed financial reporting. You must also pay annual fees and hold regular shareholder meetings. 

Should I Make My LLC an S Corp for Tax Benefits? 

There is a slight difference in taxes for LLC vs. S Corp. Electing S Corp status for your LLC could be a good idea if you’re likely to pay a lot of money in self-employment taxes. 

With S corp status, you can divide your business income between the salary you receive as an employee and your distributions as the S Corp owner. You would pay self-employment taxes on your salary, but the rest of the money would be exempt. 

Work With a Small Business Tax Expert to Maximize Your Savings

If you need help determining what the best choice for your company might be, feel free to consult with a professional. Regulations can vary by state and industry, and your best bet is to seek an expert who can consider your situation. 

Count on the trusted professionals at 1-800Accountant to guide you through your small business taxes. Get the help you need to protect your business and give you answers on LLC vs. S Corp taxes. 

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.