top of page
Writer's pictureRebecca Schug

Choosing the Right Business Entity: LLC vs. S-Corp - Weighing Tax Advantages, Simplicity, and Payroll Considerations

Selecting the right business entity is a crucial decision that significantly impacts your business's taxes, liability, and operational structure. Limited Liability Companies (LLCs) and S-Corporations (S-Corps) are two popular choices for entrepreneurs due to their distinct benefits and flexibility.


There are advantages and disadvantages to each structure, only you can determine what is the right option for your business situation. Levelheaded Bookkeeping can help you explore the differences between LLCs and S-Corps, highlighting their tax advantages, simplicity in operation, and considerations regarding payroll.


Understanding LLCs and S-Corps

Before we discuss the details and differences between an LLC and an S-Corp business entity and how they affect your finances we need to define each one.


A Limited Liability Company is a business structure that combines elements of both partnerships and corporations. Most often it is referred to as an LLC. It offers limited liability protection to its members, shielding them from personal liability for the company's debts and obligations. In an LLC, profits and losses can pass through to the individual members' personal tax returns, allowing for "pass-through" taxation.


An S-Corporation (S-Corps) is a corporation that has elected to be taxed as a pass-through entity. Like LLCs, S-Corps provide limited liability protection to shareholders, shielding them from personal liability. S-Corps differ from LLCs in that they have a more structured management and governance system.


3 Tax Advantages of LLCs vs S-Corps


Pass-Through Taxation

Both LLCs and S-Corps offer pass-through taxation, which means that business income is not taxed at the entity level. Instead, profits and losses "pass-through" to the individual members or shareholders, and they report them on their personal tax returns. This avoids double taxation, which occurs when C-Corporations are taxed at both the corporate level and the individual level when distributing dividends to shareholders.


Self-Employment Taxes

LLC members who are actively involved in the business may be subject to self-employment taxes on their share of the LLC's profits. In contrast, S-Corp shareholders who work for the company as employees can potentially save on self-employment taxes. By paying themselves a reasonable salary and receiving the rest of their income as distributions, they can reduce their taxable earnings subject to self-employment taxes.


Flexibility in Profit Distribution

LLCs and S-Corps have more flexibility in distributing profits among members or shareholders. In an LLC, members can distribute profits in proportion to their ownership percentage or agree on a different allocation. S-Corp shareholders can receive distributions based on their shareholdings and salaries, as long as they are reasonable and comply with tax regulations.


image of office workers behind a wall


Operational Differences between an LLC and S-Corp Business Structure

LLCs are generally easier to set up and manage than corporations. They have fewer formalities and paperwork requirements. LLCs are not required to hold annual meetings or keep detailed records of minutes, making them more attractive to small business owners seeking a less burdensome administrative process.


S-Corps have more formal requirements and ongoing obligations than LLCs. They must maintain proper corporate governance, including holding regular shareholder and board of directors meetings and documenting minutes. Failure to comply with these requirements could jeopardize the S-Corp's tax status.


Considerations Regarding Payroll

In an LLC, members are not considered employees, and their share of the company's profits is not subject to payroll taxes. However, if the LLC has employees, it must adhere to standard payroll procedures and withhold payroll taxes accordingly.


S-Corp shareholders who work for the company must be treated as employees and receive a reasonable salary for their services. They are required to pay themselves a salary subject to payroll taxes, including Social Security and Medicare taxes. The remaining profits, after paying salaries and other business expenses, can be distributed as dividends, which are not subject to payroll taxes.


Making the Decision: 4 Factors to Consider when deciding how to structure your business


1. Business Structure and Growth Plans

Consider the size and nature of your business, as well as your long-term growth plans. LLCs are more suitable for small to medium-sized businesses with a simpler organizational structure. S-Corps are typically favored by businesses with growth potential, as they provide a more formalized structure.


2. Number of Owners and Investors

LLCs can have an unlimited number of owners, making them an attractive choice for businesses with multiple stakeholders. S-Corps, on the other hand, have restrictions on the number of shareholders and only allow U.S. citizens or residents as shareholders.


3. Liability Protection

Both LLCs and S-Corps offer limited liability protection but the details of protections vary. It is essential to understand the extent of protection each entity provides and how it may apply to your specific business activities.


Members of an LLC are protected from personal liability for business debts and claims, beyond their investment in the company. However, this protection can be removed in cases of fraud or illegal activities. It is critical to maintain a clear separation between personal and business finances to uphold limited liability protection.


Similar to LLCs, S-Corp shareholders have limited liability protection, meaning they are not personally responsible for business debts and liabilities. Shareholders must adhere to corporate formalities and keep their personal and business affairs separate to ensure liability protection.


4. Tax Considerations

There are tax considerations when deciding on an LLCs vs S-Corps which revolve around self-employment taxes, administrative requirements, and flexibility in choosing tax status. The choice depends on factors such as the expected income, the desire for simplicity, and the potential tax savings from the S-Corp structure's ability to reduce employment taxes.


Examine the tax implications of both entities and how they align with your financial goals. Levelheaded Bookkeeping can guide you in the tax considerations that apply to your business now and in the future.


Setting Your Business Up for Success

Choosing the right business entity is a critical step in setting up your business for success. LLCs and S-Corps offer unique advantages and flexibility in tax planning, simplicity in operation, and considerations regarding payroll. While both entities provide limited liability protection and pass-through taxation, they differ in their formalities and requirements.


Consider your business's size, growth plans, ownership structure, and long-term goals when making this decision. Seeking guidance from a qualified attorney and a tax professional like Levelheaded Bookkeeping will help ensure you select the best entity to optimize your business's financial and operational success.



10 views0 comments
bottom of page