Search
S Corporation or LLC - What am I Missing?
Question: My business is incorporated and I elected S corporation status. Most of the business owners I know are doing business as LLC's. Am I missing something by being an S corporation?
Answer: Entity selection and tax planning for an entity are advanced topics. This planning requires consultation with your tax preparer (preferably a CPA) and your lawyer. At different times in the life-cycle of a business different entities and different planning may be appropriate for a variety of reasons. Be sure to seek competent professional help in entity and tax planning.
To respond to your question, there may be a good reason for you to be an S corporation. That could rest in the application of self-employment tax. How money is distributed from a business entity makes a difference. A salary or wage is a payment by a business in exchange for services rendered. A distribution is a payment taken out of the profits or other assets of the organization. There is no federal tax law requirement that shareholders (owners) of an S corporation or the members (owners) of an LLC pay themselves a salary. They can decide to receive money from the business only as distributions or keep profits in the business as equity to be distributed at a later time. However, the application of the federal self-employment tax (Social Security and Medicare tax for individuals who work for themselves) should be considered. With an S corporation, wages are subject to self-employment tax, but distributions are not. (Both wages and distributions are subject to regular federal income taxes.) S corp shareholders who take only distributions must still pay self-employment tax on an "industry standard" amount of salary or risk an IRS challenge. Therefore, many S corp shareholders elect to take at least a small salary limited to that industry standard to minimize self-employment tax liabilities. What is industry standard is not always clear, but the IRS will challenge salaries it deems too low. Owners of an LLC are deemed to be self-employed and must pay self-employment tax on all money taken from the LLC whether classified as wages (salary) or distributions. In certain situations, the application of the self-employment tax can generate higher tax burdens for LLC owners, and the S corporation offers a lesser tax burden.