As a small business owner, you can choose how to structure your business for tax purposes. The most common options are:
- LLC filing as an S-Corporation for tax purposes
A common misconception I see among business owners is picking a business structure and then making up their own rules as they go. In reality, each option comes with specific requirements for how you file taxes and conduct your business.
We’ll break down each of the options so you can fully understand the pros and cons of each and make sure you’re in compliance.
An LLC, or Limited Liability Company, is considered the simplest way of establishing a business that’s separate from you as an individual. Meaning, if your business is sued, your personal assets are protected. In addition to being relatively easy to establish with minimal hassle or required reporting, the benefits of creating an LLC include:
- Flexible ownership and management
- An LLC does not pay taxes and does not file a return with the IRS
- Profits (or losses) are reported on a Schedule C, which is an addition to your personal 1040 tax return
- LLC members are not employees, so the burden of payroll reporting doesn’t exist when the business is just starting out
S-Corporations are a bit more complex. They require more paperwork than LLCs, because they require a board of directors, regular meetings, and board minutes. There may also be additional state requirements. Some differences from an LLC include:
- S-Corp owners must structure themselves as employees and receive salaries.
- The IRS states that for S-Corp owners, “your salary must be reasonable and align with your actual responsibilities of the business.” This prevents you from taking a low salary to avoid a high self-employment tax.
- S-Corporations don’t pay self-employment taxes on distributions to owners.
LLC filing as an S-Corporation
As a business grows and becomes profitable, the owner of an LLC might want to become an S-Corporation for the tax advantages. Rather than dissolving the LLC and forming an S-Corporation, this option can avoid state requirements like the board of directors, board meetings and board minutes.
When the company generates enough profit to make the change in tax structure worth it, it could be a good time to consider becoming an S-Corp. There are many factors that go into making this decision, but the more profitable your business becomes, the more advantageous it is to make this election. Consulting your tax advisor is the best way to decide, because this person knows her personal and business situation best.
Each business is unique, so there’s no generic answer to the question of how to structure and file taxes. The best thing you can do is do your homework, seek wise counsel from experts, and decide which option is most beneficial for you and the trajectory of your business.
If you want to learn more about S-Corps and LLCs, let’s talk. Schedule a call and let’s find ways to keep more profits in your pocket.