Are you looking to start your own business in 2020? You’ve come to the right place. Moving into the world of self-employment can be extremely rewarding if done correctly. While there are many steps that will determine your success, the framework for it all begins with a simple question: What type of business structure are you looking for?
Most people narrow it down to one of two options – LLC vs. S Corporation. What are the strengths and weaknesses of going either route? Is there one that’s a better fit for you than the other? Read below as we explore these questions and more.
LLC stands for “limited liability corporation.” Like a “sole proprietor,” “partnership,” or “corporation,” an LLC is a business entity. It’s a matter of state tax law that gives owners the freedom to start their own business without the liability that comes with it should things not pan out. In other words, LLCs protect their owners’ non-business assets in the event of a lawsuit or other negative circumstances.
With that protection also comes higher tax spend as the business grows, however. Anyone who starts an LLC will need to pay a 15.3% self-employment tax. Additionally, all income generated by this type of business is considered taxable income, which means little to no room for tax write-offs.
Unlike LLCs, S Corps are a matter of federal law instead of state law. They are more of an elected way of how your business will be taxed than they are a business classification. For example, in some circumstances, your business could be both an LLC and an S Corp. They were created in order to help Americans avoid double taxation and even have the ability to issue their own stock.
While it definitely has its benefits, there are also some notable limitations about S Corps that you should know. S Corps cannot have more than 100 shareholders, each of which must be American citizens. LLCs, in contrast, don’t have limits for membership or citizenship. Additionally, while you may not need to pay employment tax, you will still be required to pay yourself a salary in accordance with the IRS’s reasonable compensation regulations.
Which One To Choose
The truth is, every business is unique and has its own set of challenges to overcome. We cannot give a specific LLC vs. S Corp answer without first sitting down with you and discussing your priorities with your new business.
In the startup stage, LLCs provide unparalleled protection and flexibility. However, as your business expands over the years, and S Corp may make more sense for you financially since there will be fewer taxes to pay overall.
A great strategy would be to start out as an LLC, and once your business hits the $55k-$60k yearly income mark, consider getting it taxed as an S Corp as well. This way, you get to divide what’s coming in between dividend income and personal income and get yourself to an overall lower tax rate in doing so.
If you would like to learn more about how we can help you and your business improve its accounting practices, reach out to our team. For more information on other accounting topics, check out our blog.