What is the Difference between an S-Corp and a LLC?

What is the difference between an LLC and A S-Corp?

We understand that choosing a business structure is an important step for someone starting their own business. With the vast amount of knowledge on the internet, it’s easy to get confused among all the technical terms. This post aims to simplify all of them and make it easy for you to make an informed decision about your business. 

 

We have called upon over 10,000 business owners for advice on this, and we would like to share their insights in a simple way to make them understandable and useful for future business owners. 

 

Let’s start with the term LLC. It stands for limited liability company as opposed to the commonly believed “limited liability corporation.” For the sake of this Article, we will assume the LLC is being taxed on a pass-through basis, not as an S-Corporation or C-Corporation. The LLC was created to be a simplified business structure in comparison to the corporation. However, it’s noted that this simplification has some downsides, and it is especially important for small businesses to understand its application. 

 

Figuring out what position the company’s owners will hold within the business will make it easier for you to decide which structure is best. The question is if they are going to be hands-on in the daily operations or passive in the work decisions. 

 

What is a Hands-On Owner?

This refers to an owner who participates in the day-to-day working of their own business. An example would be if you start a clothing company, then what would be the owner’s role in the work? Will they design clothing, track down suppliers, find distributors, communicate with sponsors, and build a website, among other tasks? If this is the case for you, then you are a hands-on owner.

 

What Is A Passive Owner?

This owner doesn’t work for their company. They prefer to wait for results after making an investment in the business. One of the most common examples is a real estate owner. They rent out a property after purchasing it, effectively letting go of their daily operations in real estate. They just focus on collecting the rent and letting the renters be on their own. 

 

What is the Best Structure for You?

 

Now we know how to identify what kind of owner you are to your business, so let’s find the perfect business structure for you. One unspoken rule is that hands-on owners should opt for an S corporation while passive owners should go for registering an LLC.

 

The reason behind that is taxes.

 

Both LLC and S Corporations provide liability protection to the owner’s personal assets in case any liability is incurred by the company. They also have a pass-through tax structure, which lets the company not pay income tax at the end of the year, and the profits and losses are handed down to the owners of the company. 

 

The main difference is the way owners must pay income tax on the profits they receive from an LLC or an S corporation. When you are an owner of an LLC, if the income is not derived from a passive business activity, it is subject to self-employment tax. In an S Corporation, the owners are able to control the tax by becoming the employees of their own company. 

 

The company’s owners are seen as the employers in an LLC, but in an S corporation, the owners may become employees and W-2 themselves with a percentage of the proceeds.

 

What Is Self-Employment Tax?

To put it simply, this is the amount of tax that business owners pay. It is like the taxes employees pay on their paychecks. It includes their medical care and social security payments. Owners are most likely to pay this tax at the end of the year or quarter prepayments. 

 

Example 

Let us keep the following assumptions in mind:

·         A company earns $200,000 after all expenses.

·         The self-employment tax is 30%

·         The passive income tax rate is 15%.

In an LLC, the owners would take the $200,000 and would pay $60,000 as tax in installments or at the end of the year.

 

In the case of an S Corporation, the owners of a company can claim they received $100,000 as salary for the work that they did for the company, for which they will pay the same 30%, i.e., $30,000 in taxes. Now, the owners of the corporation could accept the remaining $100,000 as a distribution from the company. It would be taxed at 15% as a passive income rate and would require $15,000 in taxes. 

 

This example showed how S corporation owners were able to save $15,000 in taxes for the year. 

 

To sum it up, our aim was to make it easier for you to determine what business structure is right for you and understand the difficult technical terms related to it. It is still an important and central decision for the future of your business, so it is strongly recommended that you consult with a BusinessRocket Onboarding expert to help you with this decision. You can call us at 310-424-5558 Extension 1 to speak with someone that can help guide you to answering the question about which business structure is best for you. 

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