LLC vs. S Corp: Which Is Right for Your Small Business?
"Should I be an LLC or an S corp?" is one of the most common questions small business owners ask, and it is a little bit of a trick question. An LLC is a legal structure created under state law. An S corporation is a tax election made with the IRS. Many small businesses are both: an LLC that elects to be taxed as an S corporation. Here is how to think about it.
1. What an LLC does
A limited liability company separates your business from you personally, which can protect your personal assets from business debts and lawsuits if you keep the business truly separate. For federal taxes, a single-member LLC is ignored by default: profit goes on Schedule C of your personal return, and you pay self-employment tax (about 15.3 percent) on nearly all of it.
2. What the S corporation election does
When an LLC (or corporation) elects S status by filing Form 2553, you become an employee of your own company. You pay yourself a reasonable salary through payroll, which is subject to payroll taxes. Profit above that salary can be paid out as distributions, which are not subject to self-employment or payroll tax. That difference is where the savings come from.
3. When the S corp math works
The election usually starts to make sense once profit is comfortably above what a reasonable salary for your work would be, often when net profit reaches roughly $50,000 to $80,000 or more, depending on your industry and state. Below that, the savings are small and can be wiped out by the extra costs.
4. The costs people forget
Running payroll (software or a provider), with quarterly payroll filings and W-2s
A separate business tax return (Form 1120-S), which usually costs more to prepare
State fees or taxes; some states treat S corporations differently
More bookkeeping discipline: no mixing personal expenses, and accountable plans for reimbursements
5. "Reasonable salary" is not optional
The IRS expects owner-employees to pay themselves a salary comparable to what they would pay someone else to do the job. Paying yourself $0 or a token salary and taking everything as distributions is one of the most common audit triggers for S corporations, and it can lead to back payroll taxes and penalties.
6. A simple example
A consultant with $120,000 of profit who elects S status and pays a $65,000 reasonable salary pays payroll tax on the $65,000 instead of self-employment tax on nearly all $120,000. The difference can be several thousand dollars a year, before subtracting payroll and return-preparation costs. The exact answer depends on the numbers, which is why it is worth running them before electing.
7. Timing
To take effect for a calendar year, the S election generally must be filed within the first two and a half months of that year (by about March 15), or within two and a half months of a new entity's start. Late-election relief exists, but it is easier to plan ahead.
Bottom line
Form the LLC for liability protection. Consider the S corporation election once your profit clearly supports a reasonable salary plus the extra costs. Run the numbers with a tax professional before you file Form 2553.
This article is general information, not tax advice for your specific situation.
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