Selecting the appropriate business Structure is crucial for liability protection, tax efficiency, and operational flexibility.
LIMITED LIABILITY (LLC)
First, there are no tax advantages (or disadvantages) to forming an LLC. In fact, forming an LLC won’t change a thing for Federal income tax purposes. Single-owner LLCs are taxed just like sole proprietorships, and multiple-owner LLCs are taxed just like partnerships.
You should, however, be aware that forming an LLC might subject your business to additional state taxes. Certain states (California for instance) subject LLCs to “franchise taxes” in addition to a typical income tax.
S CORPORATION (S CORP)
S-Corporations have the ability to provide some tax savings as a result of the fact that profits from an S-Corp are not subject to self-employment tax. However, before you’re allowed to distribute any profits, you are required to pay any owner-employees a “reasonable salary.” This salary will be subject to Social Security and Medicare taxes (which total the same amount as the self-employment tax). As such, the tax savings only take effect once the business has a pretty sizable income.
Also, you should be aware that S-corporations are significantly more complicated from a tax and legal standpoint than LLCs. So if you form an S-corp, know that you’re going to be spending a great many more billable hours with your accountant/attorney.
S CORP ELECTION
An S Corporation (S-Corp) election allows an LLC to be taxed as an S-Corp rather than the default sole proprietorship or partnership structure. By electing S-Corp status with the IRS (using Form 2553), LLC owners can potentially reduce their self-employment tax liability. This is achieved by splitting income into two parts: a reasonable salary paid to the owner (which is subject to payroll taxes), and remaining profits distributed as dividends, which are not subject to self-employment tax.
This structure can result in significant tax savings, especially for businesses generating consistent profits. Additionally, an S-Corp still provides the limited liability protection of an LLC while offering a more favorable tax structure for growing businesses.
What's best for you?
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