Do you have questions about the Tax Difference between and LLC and S Corporation? Are you wondering how much taxes you might save with an S Corp conversion rather than being taxed as a Sole Proprietor?
Watch The Video Below.
LLC vs. S-Corp What's the Difference between an LLC and an S-Corporation
I put this video together about 3 years ago when I was in the thick of growing Nuance Financial Tax and Accounting - which is probably the most customer centric, helpful, and impactful CPA, Tax, Bookkeeping and Payroll company in Minnesota. They have a service called their "Outsourced Accounting" where they serve as your bookkeeper, payroll provider, payroll administrator, financial administrator, tax preparer and tax planner - all with amazing customer service through the cloud and over the phone. Bottom line - is for $500/month for single owner S-Corps, or about $450/week for businesses with more employees, you don't have to hire the litany of service and staff that are hard to execute on.
LLC vs. S Corp Simplified:
Here's the most basic explanation we could put together of the difference between an LLC and an S-Corporation - Enjoy!
Let us know how you like it!
Both are Limited Liability Passthrough Entities.
Well first off, both of them are actually LLC’s. When we refer to an LLC, we’re talking about an LLC taxed as a Sole Proprietor - We’ll just call it an llc
And then when we talk about S-Corp, we’re actually referencing and LLC taxed as an S-COrporation.
Both LLC’s and S-corps provide business owners with a couple of things.
Legal protection so that there is a corporate veil between the companies assets and your personal assets.
They provide some operational advantages like partnerships and the ability to collaborate with others
And they both serve as pass-through tax entities, which means the profits and losses will flow through to the business owner.
Let’s get a little more specific.
For both an LLC and an S-corp, you’re going to be figuring out your tax on your - net profits - which is what’s left after you subtract all your deductions and write offs from your businesses gross income.
Now in an LLC, your entire net profit will be subject to what’s called Self Employment tax.
Remember when you were an employee at another company and you’r paycheck had that little “FICA” and “MEDICARE” deduction. Well, when you have an employer & employee relationship your employer would have paid half of the social security and medicare tax, while the employee paid the other half.
Now that you’re “self employed”, you’ll get to pay the entire thing which is 15.3% of all net earnings up to the social security limited which changes each year but was 118,500. After you hit the social security limit, all your earnings above that you’ll owe medicare taxes which is 2.8%
First Self Employment Tax, THEN Federal and State Income Tax.
THEN, after you pay your self employment tax, you’ll be subject to state and federal income tax. This is simplifying it a bit, but essentially you’ll be paying an increasingly higher, or “marginal” tax rate on those earning. The more you earn, the higher your tax rate!
So with an LLC, you’ll pay a 15.3% self employment tax on your net profits then you’ll pay state and federal income taxes.
LLC Sole Prop Tax Example:
Let’s look at a quick scenario focusing on just the self employment taxes for a fictitious LLC taxed as a sole proprietor.
Here if you had taken in total revenue of whatever, then after your deductions & expenses - you had a net profit of a $100,000 your self employment tax bill comes out to $15,300 dollars.
$100,000 in Schedule C = $15,300 in SE Taxes. (simplified for clarity)
Breaking that down bit, that’s a monthly bill of $1,275 dollars JUST for your self employment taxes.
Now after your done with those self employment taxes, you’ll still owe your state and federal taxes… Which, if you were single, and had $85,000 in taxable income - just your federal income tax bill would be about 17,325 on top of your self employment taxes…
That’s not even factoring your State income tax, property tax, or anything else you pay….. that seventeen thousand dollar income tax - is just for a single person paying federal income tax on 85,000 in income.
This puts your total tax bill, EXCLUDING fees, sales tax, property tax, state income tax, or other dues …….at a very conservative $33,000 dollars a year.
This means You’re taking home $8,300 a month in income, and writing a check to the government for $2,750 a month.
If that doesn’t get your heart racing a bit, I don’t know what will.
So what can we do about this conundrum? Well, the most popular strategy employed is incorporating to an S-Corp.
With an S-Corp, you’ll incorporate and become an employee of your corporation. Then you will take TWO forms of income.
The fist part of your income…. is that you'll pay yourself a salary …...and the second part of your income is what’s called a distribution or a “dividend”.
So we’re going to split up the income into these two parts, the salary and then the distribution. What you’ll see in a minute is that the salary is subject to the 15.3% self employment tax while the distribution is not…. so you’re paying 15.3% on your salary, but not not on your distribution.
Because the distribution income is not subject to that 15.3% self employment tax, the temptation can be to falsely shift all of your income over to a distribution & not take a reasonable wage.
which is why the first part of your income, the “salary” also called a “wage” or “payroll”, must BE REASONABLE according to the IRS. There are multiple factors that dictate what kind of a salary you need to pay yourself. The salary needs to be reasonable for your experience, comparable salaries, economic conditions, and a bunch of other factors. This is super important, because you
So now lets look at a fictitious S-Corp example
Now starting with the same 100,000 of net profit, you will pay yourself for this illustration - a 60,000 salary. Then, you would take out 40,000 in distributions.
The tax benefit is that the salary is subject to the 15.3% self employment tax, but the distributions are NOT subject to the self employment taxes. This means that 40,000 in distributions are not subject to a 15.3% tax! Putting your total self employment tax due down from 15,300 to 9,180…. which is a 40% decrease!
Rather than paying1,275 a month in self employment taxes as an LLC, you’ll be paying 765 a month as an s-corp.
That means you’ve essentially freed up $510 dollars in monthly cash-flow in this scenario.
In a scenario like that, 510 dollars a month can easily help you save for retirement, payoff your mortgage early, hire some help, advertise, or invest in real estate sooner…….
Now, if you’ve already become an LLC, and you like the idea of becoming an S-Corp, you have to file for an S-Election before March 15th - or you’ll have to wait till the next year.
Strategies that utilize an S-Corp can give you tools to help mitigate your taxes, but these strategies should be handled by a competent CPA or tax professional. Here at Nuance Financial, we specialize in helping small businesses from across the country implement these strategies as part of a long term solution.
Check out the description below to learn more and go to NuanceFinancial.com for a free consultation.