LLC or S Corporation?
There are a lot of benefits to having your business be taxed as an S Corporation. While an S Corporation can mean more work (payroll, extra tax forms, etc.), the additional tax savings usually outweigh the potential drawbacks.
When you form a single-member LLC, the default tax deduction will be as a sole proprietor. That means you report the business profit and losses on Schedule C with your personal 1040 tax return. But if you elect to have the LLC be taxed as an S Corporation, you have to file a separate form to report the business income.
So, which is better for your business? In most cases, you and your business will benefit from electing S Corporation tax treatment.
Audit risk: One great advantage of an S Corporation is the audit risk; a single-member LLC that files the Schedule C with your personal return is about a thousand times more likely to be audited than an S Corporation. Advantage: S Corp!
Reduced taxes: A Schedule C tax-payer generally must pay self-employment tax on all income after expenses up to $118,000 for 2015. But in an S Corporation, the owners are required to pay themselves a reasonable salary, and only that salary is subject to self-employment tax. Advantage: S Corp!
Special deductions: Health insurance, health savings accounts, and Medicare are fully deductible in an S Corporation, whereas in a Schedule C, they are subject to self-employment tax. Advantage: S Corp!
Contributing to a SEP pension plan in an S Corporation results in a deduction from self-employment tax and regular tax. Contributing to the same pension plan on a Schedule C does not reduce self-employment tax. Advantage: S Corp!
Home office: Joe and Natalie recommend that the S Corporation owner reimburse her mileage, cellphone usage, and office in the home expenses. In the office in the home reimbursement, there is no depreciation because that is not really a reimbursable expense. In a Schedule C, the expenses are basically the same, however you are required to depreciate your residence. Then when you sell your residence, you do have to recapture the depreciation. So, you do not have to recapture the depreciation in an S Corporation, but you do in a Schedule C. Advantage: S Corp!
Risk of underpayment: Active S Corporation owners are required to take a reasonable salary from the business. Joe and Natalie recommend that all income taxes are paid through the salary, therefore eliminating estimated payments. Schedule C filers are required to pay estimated tax payments each quarter. A lot of times, if the business fluctuates, goes up and goes down and they make more or less income, they are not properly paying in their estimated payments, which could result in additional tax owed on April 15th. Advantage: S Corp!
The drawbacks of an S Corporation: The reasonable salary requirement of an S Corporation does increase the complication since you have to make sure your “reasonable salary” is reasonable in the eyes of the IRS. A Schedule C, on the other hand, does not have to worry about a “reasonable salary” and makes it simpler to pay yourself from the LLC. Advantage: Schedule C!
Loan issues: If the business is going to obtain a large loan, such as an SBA loan or other loan from a bank, it could be more advantageous to file a Schedule C. It gets kind of complicated, but it creates a basis issue in the S Corp. In that case, advantage: Schedule C.
Trying to decide if your LLC should be taxed as an S Corporation? Talk to a CPA!! Joe and Natalie make it really easy and inexpensive. For one monthly fee, with an S Corp, Joseph Lutz does payroll, payroll taxes, sales taxes, bookkeeping, continual planning throughout the year, the year-end corporate income tax return and the shareholder’s personal return all free of charge. They are great! I use them myself and am very happy with their services! Their contact information is:
Joseph D. Lutz CPA, LLC