Last month, we examined the selection of which entity to choose based on the perspective of the proprietor through the lens of the Limited Liability Company. To recap last month’s conclusion:
Limited Liability Companies are becoming more popular. This is because most business owners want a limit on liability, single layer taxation, minimum formalities, and still enjoy the protections. The LLC is definitely worth consideration.
While the LLC has some big advantages, the S Corporation is not out of the race yet. This month we examine the S Corporation.
Subchapter S Corporation
To begin with, the self-employment tax is 15.3% for those who are self-employed and encompasses both Medicare and Social Security taxes.
Profit (not salary/compensation paid) from an S Corporation is not subject to self-employment taxes. Normally when a person is employed by an employer, their employer pays half of the tax subjecting the employee to only paying half of the full tax. When one is self-employed, they must pay the full tax by themselves. Under the use of a Subchapter S Corporation, salary (not profit) is subject to self-employment tax. However, if the salary is deemed insufficient, the IRS can reclassify the profits as a salary subjecting them to self-employment taxes.
This is in contrast to LLCs. While operating under an LLC, both salary and profits are generally (but not in all cases) subject to self-employment taxes. For people with incomes below the social security maximum threshold amount, this can result in a significant amount of money being put into self-employment taxes. That being said this can be good or bad depending on your retirement planning needs and expectations.
Since S Corporations are flow through entities, losses can be deducted. This also holds true for the LLC. However, this is in contrast to C Corporations in which shareholders cannot deduct losses. If an S Corporation is experiencing losses, the owner will recognize the loss on his or her income statement leading to a lower tax liability. However, there is a limit. You cannot deduct amounts that exceed your investment and loans to the company.
During operation of an S corporation, profits are taxed only at the shareholder level as opposed to C Corporations, which are taxed twice. Just like with the LLC, the profit, not the distributions are taxed. This can be good or bad depending on the situation.
When winding up the affairs of the entity and dissolving the business, profits are taxed once. As stated above, all businesses eventually close their doors and their assets are sold at one point or another. With an S corporation this transfer is only taxed at the shareholder level.
Of less importance, the franchise fee and start up filing fees that S Corporations pay are substantially less than that of LLCs. Generally S Corporations will pay in the area of $50 per year in fees and LLCs can pay $300 – $500 per year.
There is no one “be all, do all” separate entity for the business man or woman. Each entity has subtle differences which can make a substantial difference to the business owner. When deciding which entity type to go with, consider tax and legal aspects to the full extent necessary. The Center is well adept to providing, setting up and maintaining entities such as those discussed above. Call The Center for these and all of your other financial, legal, and tax planning needs.
By: Dr. Bart Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors