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Should your business be an LLC or an S Corp?

You finally decided to start your own business. Or maybe you’re a business owner. sole or even the moonlight on the side And have decided that you need to protect your personal assets from those involved in your growing business. You may decide that a tax deduction may be available to you. Whatever your reason You too often consider the choice many entrepreneurs face: if your organization is structured as a limited liability company (LLC) or S corporation (S Corp), named after subsection S of Section 1 of the Internal Revenue Code?

These two organizational forms are similar and different. Being able to choose between these formats and others such as C corporation (which includes public companies) is confusing at best. Each state may have different rules. That’s why you want to get information from a respected accountant and/or attorney. 

Determination of benefits

A major advantage of organizing your business as an LLC or S corp is that you can protect your personal assets from your business creditors. ‘Limited liability means that you cannot be held financially responsible for more than your investment in the Company,’ writes Greg McFarlane in his book. Control Your Cash: Making Money Reasonable. ‘If you put in $10,000 and incur $11,000 in debt, you could only be liable for $10,000. your creditor (Make sure your LLC creditors) cannot ‘penetrate the corporate veil’ as mentioned.

Another common characteristic of LLCs and S corps is that they help you avoid paying personal and corporate taxes. The difference is that in an S corp, the owner pays himself a S Corp Reasonable Salary and receives dividends from the additional profits the company may receive, whereas in an LLC, it is a ‘pass-through entity, which means that all income and expenses from the business are received. reporting On the LLC entrepreneur’s personal income tax return, says Ebong Eka, a CPA who writes his own blog about the world of entrepreneurship at taxsaversonline.com. Both LLCs and S corps can deduct pre-tax expenses such as travel, uniforms, computers, phone bills, advertisements, promotions, gifts, car payments, and health insurance premiums, McFarlane writes.

Notice the Differences

Now that you understand the benefits that LLCs and S corps have, it’s time to explore the pros and cons of each. Here are some key differences according to Eka:

LLC Pros:

Sole-member LLC owners do not have to file tax returns for LLCs because they only report activity on their personal tax returns.

Easy Setup: Most LLC forms are just one page for a single-member LLC.

Inexpensive to Startup: The cost of forming an LLC is also affordable. Usually only two hundred dollars.

Best Practices: The red tape associated with forming an LLC is not as stringent as it is associated with S corps, leading to savings on account and attorney fees, among others.

LLC Cons:

Self-Employment Tax: Single-member LLC owners must pay self-employment tax on income generated in the LLC, which is estimated quarterly payments to the IRS.

LLC owners must ensure that they do not penetrate the ‘corporate curtain,’ meaning they must operate the LLC separately from their personal affairs. The LLC corporation must not be a shell. It is an operating entity,’ says Eka. ‘There are cases where a business owner loses protection because there is no clear distinction between an LLC and its owner.’

An S corp’s major advantage is that it provides tax benefits when it comes to excess profits, also known as distributions. S corps pay ‘reasonable’ salaries to employees. This means that it should be linked to industry norms. At the same time, payroll expenses such as federal taxes and FICA are deducted. The remaining profit from the company can then be distributed to the owners as dividends. which will be taxed at a lower rate than income.

S Corp Disadvantages:

Reasonable Salary for S Corp Owners have stricter guidelines than LLCs under tax laws. Eka says that you must meet the following criteria to create an S corp: Must be a U.S. citizen or resident. No more than 100 shareholders (spouse is considered an independent shareholder for the purposes of this rule). A company can only own one class of shares. Profits and losses must be distributed to shareholders in proportion to their equity. For example, you cannot have disproportionate dividends or losses. If a shareholder owns 10% of the S corp, he or she must receive 10% of the profit or loss.

It costs more to set up an S corp.

Shareholders must comply with the requirements at all times. If not They risk disallowing an S corp elected, and the corporation will be treated as a C corporation with corresponding restrictions.

  • Passive Income Limits: You cannot earn more than 25 percent of your gross income from passive activities, such as real estate investing.
  • Additional state taxes may apply for S corps.
  • Shareholders should pay attention to payroll. It is ‘reasonable’ to themselves for the work they do in S corps as the IRS is increasingly screening S corps for this.

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