Introduction 

LLCs and S corporations are two terms that are often used in the context of business formation and taxation. However, they are not exactly the same thing.

Key Points

• LLC is a state level entity and is not a tax entity.
• For federal and state prospective, a LLC will be taxed either as sole proprietor, or partnership without an election.
• S Corp provides tax advantages over sole proprietor and partnership. However, comes the cost of tax return filing, running payroll etc.

Topic

LLCs and S corporations are two terms that are often used in the context of business formation and taxation. However, they are not exactly the same thing. Here is a brief explanation of what they are and how they differ:

• An LLC, or limited liability company, is a legal business structure that protects the owner’s personal assets from the company’s debts. An LLC is considered a separate entity from its owner, which means that there is a financial barrier between the company and the owner.
• An S corporation, or S-corp, is a tax classification that is available to some small businesses. An S-corp is not a separate legal entity, but rather a way of filing taxes with the IRS. An S-corp elects to pass its income, losses, deductions, and credits through to its shareholders, who report them on their personal tax returns. 
• An LLC can choose to be taxed as an S-corp, if it meets certain requirements, such as having no more than 100 shareholders, having only one class of stock, and having only eligible shareholders (such as individuals, certain trusts, and estates, but not partnerships, corporations, or non-resident aliens). By electing S-corp taxation, an LLC can reduce its self-employment taxes, since only the wages paid to the members are subject to these taxes, and not the entire net income of the LLC
• However, an LLC that is taxed as an S-corp also has to comply with more rules and regulations, such as filing annual reports, keeping minutes of meetings, paying reasonable salaries to its members, and distributing profits and losses in proportion to the ownership shares3. An LLC that is taxed as a partnership or a sole proprietorship has more flexibility in how it manages and distributes its income.
• Both LLCs and S-corps offer limited liability protection for their owners, meaning that they are not personally responsible for the debts and obligations of the business, unless they have personally guaranteed them or have acted fraudulently or illegally. However, LLCs and S-corps are not immune from lawsuits, and they may still need to obtain insurance or other forms of protection to cover potential liabilities.
• Some of the benefits of S corp are:

• S corp avoids double taxation, which means that the income of the business is not taxed at the corporate level, but only at the individual level of the shareholders.
• S corp reduces self-employment taxes, which are the Social Security and Medicare taxes that self-employed individuals have to pay. By paying a reasonable salary to the shareholder-employees, the remaining profits of the business are not subject to these taxes.
• S corp offers limited liability protection for the shareholders, which means that they are not personally responsible for the debts and obligations of the business, unless they have personally guaranteed them or have acted fraudulently or illegally.
• S corp allows the shareholders to deduct the cost of their health insurance premiums from their taxable income, as long as the premiums are paid by the business and reported as wages to the shareholder-employees2.
• S corp enables the shareholders to take advantage of various retirement plans, such as 401(k), SEP IRA, or SIMPLE IRA, and to make tax-deductible contributions to these plans, which can help them save for their future2.
• These are some of the benefits of S corp that can help small businesses save money on taxes and protect their assets. However, S corp also has some drawbacks, such as the limitations on the number and type of shareholders, the requirement to file annual reports and keep records, and the risk of losing the S corp status if the rules are not followed. Therefore, it is important to weigh the pros and cons of S corp and consult a tax professional before making a decision.

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Contact Surya Padhi at Sure Financials for any questions and clarification. Surya Padhi is an expert who keeps current on tax law changes as well as a member of the National Association of Tax Professionals National Association of Tax Professionals (NATP) and  New Homepage – National Association of Enrolled Agents (naea.org). Visit Welcome | Sure Financials & Tax Services, LLC (surefintaxsvs.com) for more information and contact us by calling +1 908.955.0696.