Choosing the right business structure is a crucial step for solo entrepreneurs and small business owners. It not only helps protect personal assets but also optimizes tax strategies. While forming a business entity is not mandatory for deducting business expenses, many owners opt for an LLC or S-Corporation to gain liability protection and tax benefits.
Key Differences Between an LLC and an S-Corporation
Both LLCs and S-Corporations are pass-through entities, meaning that profits are taxed on the owner’s personal return rather than at the business level. However, there are significant distinctions between the two:
- LLC: This structure is simple to manage with minimal formalities. All profits pass directly to owners as self-employment income.
- S-Corp: This structure requires corporate formalities such as board meetings and record-keeping. Owners must be paid a reasonable salary, but it allows some income to be taken as dividends, thereby reducing self-employment taxes.
Tax Savings: How an S-Corp Can Reduce Self-Employment Taxes
Self-employed individuals are subject to a 15.3% self-employment tax on earnings, which covers Social Security and Medicare. An S-Corp can offer tax savings by structuring income as a combination of salary and dividends. For example:
- LLC Owner (100% SE Taxable): $100,000 profit results in $15,300 in self-employment taxes.
- S-Corp Owner (Salary + Dividends): A $75,000 salary plus $25,000 in dividends results in $11,475 in self-employment taxes.
- Savings: This results in a $3,825 reduction in tax liability.
- However, the salary must be according to fair market value so there are limits to this approach.
Choosing the Right Structure
An LLC is ideal for those seeking flexibility and ease of management. In contrast, an S-Corporation is often beneficial for businesses with growing profits that aim to reduce self-employment taxes. The advantage is that if you start as an LLC, you can later convert to a C-Corp and then elect S-Corp taxation as your income increases.
Need Help Deciding?
Our team is here to guide you through the process and ensure you choose the best structure for your business goals. Contact us today to learn more and make an informed decision.