According to these small business statistics, “52.1% of small employer firms in the U.S. are S-corporations.” On the flip side, “81% of the total small businesses, approximately 26.5 million, are non-employer companies, which means they do not have employees. ”
Which makes the most sense for my startup? Unfortunately, that depends on what your business goals are and if you plan to employ people or not. Here are some pros and cons for each entity formation.
Pros
While both entities have advantages, the main difference between an S Corp and an LLC is that an S Corp isn’t a business entity like an LLC; it’s an elected tax status. The shareholders of an S Corp receive their profits based on their ownership percentage. For example, a 50 percent shareholder gets half of the profits of the company. On the other hand, an LLC member can receive 90 percent of the profits. Nevertheless, the tax implications for each entities is different.
The tax advantages of an LLC outweigh the risks of an S Corp. While an LLC does not have a separate tax account, its owners are not personally liable for the company’s debts. The income generated by an LLC passes through to the owners as self-employment income, so the costs of running an LLC are minimal. In addition, an S Corp can elect to tax itself as an S Corp. However, not all businesses can benefit from this option.
There are some other benefits to an S Corp, which include the ability to pay its shareholders reasonable salaries. In addition, S Corps can distribute excess profits to shareholders as dividends, which are taxed at a much lower rate than ordinary income. While an LLC can be profitable even without paying salaries, an S Corp can offer significant tax advantages.
Cons
The pros and cons of an LLC versus an S Corp vary depending on the type of business and the owner’s specific goals. The right business structure will depend on your financial, lifestyle, and owner employment goals. An S Corp allows the owner to receive a salary like an employee while an LLC encourages ownership participation and active management. Here are some pros and cons of both.
An S Corp can qualify for a QBI (qualified business expense) deduction, which is a tax break for business owners. However, an S Corp is under more IRS scrutiny, which means it may be terminated if it doesn’t follow tax regulations. This requires extra time and money to fix. In addition, S Corps cannot use loans from third parties or banks as a tax basis.
Tax-wise, an S Corp is preferable. S Corps have lower tax rates than LLCs. The owners of an LLC incur steep self-employment taxes on their entire net earnings, whereas an S Corp owner can deduct taxes through salary deductions. An LLC can also get tax breaks by hiring a spouse or minor dependent and transfer ownership of the company to another owner without incurring additional taxes.
Whether or not you should use an S Corp or LLC depends on your goals, industry, and business plan. It’s not a straight-forward process. We can help you decide.
Additional Resources
Why the Legal Structure of Your Business Is Important
