One of the most common questions I receive when a client is in the process of starting a business is “Which type of entity should I use?” Although every individual’s situation is different, often the S-Corp is a preferred entity type for a few reasons.
Most people, usually without consulting an attorney or CPA, go straight to the LLC when creating a business entity. The LLC allows for limited liability with the most flexibility in structuring and ease of start-up. This is not necessarily wrong, but there may be significant tax savings in creating an S-Corp instead of the LLC.
Similar to the LLC, the S-Corp is a corporate entity with limited liability protection shielding its owners from being personally liable for company debts or expenses. The S-Corp is also a flow-through entity (meaning income flows through directly to the owners for tax purposes) similar to the LLC. However, the S-Corp has additional tax advantages that often go unnoticed.
Favorable Tax Treatment
Active members of an LLC are subject to self-employment taxes in addition to their personal state and federal income taxes. For 2017, the self-employment tax structure is 15.3% on the first $127,200 in net self-employment income, and 2.9% on higher amounts.
The S-Corp, however, allows you to pay yourself a reasonable salary as well as take profit distributions. As a result, only the salary portion is subject to self-employment taxes.
For example, let’s say you are the single member (owner) of a consulting business structured as an LLC that generated $200,000 in net profits in 2016. You would be subject to approximately $21,500 in self-employment taxes in addition to your state and federal income taxes.
Instead of an LLC, let us assume that your business was structured as an S-Corp. Rather than classifying the entire $200,000 as net profits, you could pay yourself a reasonable salary of $75,000, and the remaining $125,000 becomes a net profit. As a result, you would only be subject to approximately $11,500 in self-employment taxes, therefore generating a savings of $10,000.
With such favorable tax treatment, an S-Corp is often used as a holding company vehicle for someone who owns membership interests in several LLC’s.
There are also some restrictions on S-Corps including:
1) S-Corps are limited to having 100 or fewer shareholders;
2) the shareholders must all be US citizens (no entities or foreigners);
3) only one class of stock is permitted; and
4) there may be additional corporate filings and formalities.
To make it easy for our clients, my firm charges the same fee for S-Corp formation despite there being additional filings over that of an LLC formation.
If you are interested in starting a business or forming an entity, please reach out to me to discuss the details.
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Los Angeles, CA 90067
Tel: (213) 785-1520
The content contained in this article is purely informational and should not be considered legal advice nor creating any form of attorney-client relationship. This information should not be relied on without consultation from a qualified attorney and/or accountant.