Choosing a business structure for your company is something you shouldn’t take lightly. Because the decision will impact you legally and financially, it’s important to enlist the expertise of an attorney and tax advisor to help you understand the pros and cons of each option.
The Difference Between an LLC and S Corp
As new entrepreneurs try to decide which business entity type will provide the most advantages to their small businesses, one common question they seek clarity on is: “What’s the difference between an LLC and an S Corporation?”
Let’s explore that now so you’ll have a better understanding when you decide to talk with your lawyer and accountant.
What is an LLC?
An LLC (Limited Liability Company) is a legal entity that is similar to a corporation in that it limits business owners’ personal liability and offers tax-treatment flexibility. Owners are known as “members,” and an LLC may be owned by a single member or multiple members. Another feature of the LLC is that it can be either member-managed or manager-managed. A member-managed LLC’s everyday operations are tended to by the owner(s), whereas in a manager-managed LLC, the owners designate a “manager” to take care of the day-to-day business responsibilities.
Because the IRS considers the LLC a disregarded entity for tax purposes, by default, it receives pass-through tax treatment. In other words, its profits are taxed as personal income, and the owners are directly responsible for that tax obligation. The business itself does not pay income tax.
One potential downside for owners is that all of an LLC’s profit is subject to the 15.3 percent self-employment tax burden.
But an LLC has another option that can help remedy that.
What is an S Corporation?
An S Corp is not a business structure in and of itself, but rather an alternative taxation option for corporations. LLCs, too, can elect to receive S Corporation tax treatment. By filing for S Corp status (by submitting IRS form 2553), an LLC’s profits will continue to flow through to its owners, but only the wages and salaries paid to the owners are subject to self-employment taxes. Profits distributed as dividend income are not. Therefore, an S Corp election can help reduce the amount of self-employment tax an LLC’s owners must pay.
When is the S Corporation Election Deadline?
To have S Corp election effective for the current tax year, an LLC must file Form 2553 no more than two months and 15 days after the beginning of the tax year. An LLC with a tax year that began on January 1, 2018 had until March 15, 2018 to apply for S Corp status for the 2018 tax year. If you missed that March deadline, talk to your accountant for other options.
The IRS’s instructions for Form 2553 state, “The 2-month period begins on the day of the month the tax year begins and ends with the close of the day before the numerically corresponding day of the second calendar month following that month. If there is no corresponding day, use the close of the last day of the calendar month.”
A new LLC that wants to apply for S Corp election must file no more than two months and 15 days after its date of formation. A business that wants its S Corp election effective in 2019 may file anytime during 2018.
To ensure the form is completed correctly and submitted on time, enlisting the help of an online business document filing service can save time and money.
To learn more about filing deadlines, eligibility restrictions, and other details, I recommend visiting the IRS website and talking with a business tax advisor. Also, as with any action that might impact business compliance obligations, I encourage you to talk with a business attorney to ensure you fully understand the legal responsibilities before making a change.
Photo via Shutterstock
Thanks for differentiating this. This can really get quite confusing. It is nice to see it all laid out so that you know what type of corporation you’ll register.
Okay, to be clear. Once I organize my LLC, I can elect the Filing Status of the Sub-S ?
Hi Sylvester – Thanks for reading and commenting. Generally speaking, once an LLC is organized, the LLC may elect to be taxed as an S Corporation for tax purposes as long as they meet the requirements for the Sub chapter election. To do so, you will need to directly go to the IRS.gov website to apply for the election or my company can assist as well. Feel free to email me directly at info @ CorpNet dot com
Is it possible that you can end up paying more taxes when SE tax plus Income tax (combined) vs taxes as S Corp?
Also can you hire employee(s) as an LLC?
Just seeking correct answers before I register.
Thanks in advance