In order to clear up the confusion around what an LLC versus an S-Corp business will pay in annual taxes, it’s important to understand the difference between the two and what is considered taxable income.
What is the difference between an LLC and an S-Corp company?
First, it’s important to note that “S-Corp” actually refers to a tax status rather than a type of business. An LLC (Limited Liability Company) is a deliberate, legal business structure in which one separates personal and business assets. This system protects one’s personal assets from business liabilities. Your personal income tax rate is determined by your tax bracket.
A single-member LLC is taxed like a sole proprietorship. That translates to paying 15.3% FICA tax (or self-employment tax) on all the taxable business earnings.
Setting up your business as an LLC may be less advantageous from a tax perspective if you are making a higher rate of income. This rate varies depending on your tax situation and the state you live in. To avoid paying more in taxes, you have the option to request that the IRS tax your LLC as an S-Corp. This would adjust how you pay taxes on different parts of your income (which tends to lower the bill for what you owe). Be sure to look at the implication of changing to an S-Corp within your state. In Tennessee, it does not always save you money.
Again, an S Corp (S Corporation) is not a business structure; rather, it is a tax election for a business that designates how it is taxed at both federal and state levels.
S-Corp divides taxes into income on the business and taxes on your personal salary. As an S-Corp owner, you generally must pay yourself a salary. This salary needs to be “reasonable,” in other words, comparable to what you would make as an employee doing your job.
The general breakout for S-Corp taxes is 15.3% in payroll taxes, a FUTA tax, and personal income taxes on your salary. Your company pays the other 7.65% in payroll taxes. This counts as a tax write off. The rest of your business profits could be taken as “draws.”
Here’s a chart we reference to breakdown business structures:
Entity Type / Taxable Item | How Taxes are Paid | Sole Proprietor | LLC Taxed as Sole Proprietor or Partnership | LLC Taxed as S-Corp | S-Corp | C-Corp |
|---|---|---|---|---|---|---|
Salary Paid Through Payroll | Taken Out Through Payroll | Not Permitted | Not Permitted | Generally Required & Must be Reasonable | Generally Required & Must be Reasonable | Generally Required |
Guaranteed Payments | Paid by Shareholder | Not Permitted | Permitted Only if Allowed by Operating Agreement | Not Permitted | Not Permitted | Not Permitted |
| | | | | | |
Distributions / Draws | None | Permitted but Optional | Permitted but Optional | Permitted but Optional | Permitted but Optional | Not Permitted |
Dividends | Paid by Shareholder | Not Permitted | Not Permitted | Not Permitted | Not Permitted | Yes |
| | | | | | |
Net Income of Business - Paid by Shareholder | Paid by Shareholder | Yes | Yes | Yes | Yes | No |
Net Income of Business - Paid by Business | Paid by Business | No | No | No | No | Yes |
Social Security & Medicare Taxes | | Paid by Owner on Tax Return | Paid by Owner on Tax Return | Salary has taxes paid through payroll. Shareholder pays taxes on net income of business | Salary has taxes paid through payroll. Shareholder pays taxes on net income of business | Salary has taxes paid through payroll & business. |
| | | | | | |
IRS Income Tax Return Filed | | Schedule C | Schedule C or 1065 | 1120S | 1120S | 1120 |
Both of these systems “work,” but depending on your taxable income, one or the other may be more advantageous regarding tax savings.
The driving factor for whether or not the LLC taxation or S-Corp tax status works for you is profit.
The profit your business makes plus any S-Corp salary is what determines which approach is most advantageous to you.
Income and payments to owners from the business come in several forms and are dependent upon your business type:
Payroll: This must be a reasonable amount per the IRS and must be paid regularly regardless of profit.
Guaranteed Payment: This is set up in the operating agreement and is taken regardless of profit.
Distributions: These are taxable payments of the retained earnings of a business to its owners. This only applies to C Corporations.
Draws: These occur when a business owner takes funds out of their business for personal use, and they are not taxable (taxes are paid on total earnings, regardless of whether or not draws are taken). The owner(s) need to ensure that they don’t withdraw more than the equity they have in the business.
Learn more about planning for these payments here. If you’d like assistance making a decision that best benefits your business, we’re here to help.
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