Tax Differences Between an LLC and an S Corporation

We are currently in the throngs of tax season, and some business owners are wondering which taxation method makes the most sense for their unique situation. If you’re a small business owner and would like to know if it’s more beneficial to file as either an S Corporation or an LLC, you’ve come to the right place. Known as the main two options for single-member businesses to consider, these filing methods can yield very different outcomes depending on the path you choose. 


Under the watchful eyes of the Internal Revenue Service, each has its own unique perks that accountants can help play to your favor. So, without further ado, here are the tax differences between filing as an S Corporation and an LLC:


S Corporations Vs. LLCs


To start things off, let’s go over some terminology. When choosing which type of business entity is right for your business, the most common forms are as follows: Sole Proprietorship, Partnership, C Corporation, and S Corporation. Notice how LLC isn’t listed there? That’s because it’s not considered a business entity, and is actually just a type of business structure allowed by state statute. In other words, you can elect to have an LLC, but can still be taxed as a Corporation or Partnership if you don’t want to file what the IRS calls a “disregarded entity” LLC ownership tax return. While LLCs and S Corporations have a lot in common, the main difference between them is how they are taxed regarding Medicare and Social Security.


S Corporation Taxation


Filing under the S Corporation designation gives you a bit of flexibility when paying taxes. As long as you as the owner are paid a reasonable salary for the work you do, you’ll be able to cut down on the amount of Medicare and Social Security taxes you need to pay, since S Corporations can consider their owners as employees, and their salaries as a business expense. With that said, there are also a lot more rules, regulations, and paperwork that generally go along with managing an S Corporation, so be prepared. 


For the sake of our example, let’s assume you’re a single-member business owner whose business makes $200k per year in profit. If you pay yourself a $75k salary, you essentially cut down on the overall tax responsibility you have as an individual. Instead of being on the hook for paying Medicare and Social Security taxes for the full $200k value, your business reports a total revenue of $200k ($75k of salary and $125k of profit) but is only responsible for paying those taxes on the $75k that was set aside as part of your salary. 


LLC Taxation


LLCs, on the other hand, are a little different. In this business structure, unlike the S Corporation, if you are a single-member business owner, you cannot be considered an employee of the business, and instead, are categorized as self-employed. If you have two or more members in your organization, then the IRS will instead classify you as a partnership for tax purposes. You can elect to move forward with either classification or decide to file as an S Corporation if the above-described benefits sound more appealing. LLCs come with considerably less paperwork and regulations and are a great option if you’re not going to be keeping the most detailed records for your business. 


Going back to our example of the company with $200k per year profit, if you do decide to move forward with being taxed as an LLC, it brings with it a much higher tax burden on your end. Since all profit is being grouped together as part of your personal income, you’ll have to pay Medicare and Social Security taxes for the entire $200k figure. That can be a steep tradeoff in return for more regulatory freedom.


At the end of the day, your best option is to come in and speak to a professional accountant on the pros and cons of each classification, and how they may affect your unique financial situation. Both S Corporations and LLCs can be great ways to run a small business. It’s up to you as the owner to decide which values you would like to prioritize. 


At Hall & Company, we are an Orange County CPA firm based in Irvine committed to providing quality tax and accounting services along with sound financial direction to clients throughout Orange County, California. We offer business development consulting, audit, tax preparation, IRS Audit, retirement planning, business roundtables, estate planning, QuickBooks consulting, Interim Chief Financial Officers, and a full range of traditional public accounting services.


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.