LLC vs. Corporation – How Are They Taxed?
LLCs vs. Corporations – How Are They Taxed?
Taxation status is one of the most important factors for business owners when it comes time to select their business entity. Navigating all those different tax classifications for all the different business entities can get a little overwhelming – we know – but it doesn’t have to be. Let’s start here with the differences between LLC and corporate taxes, and the different options open to both.
As far as the tax man is concerned, corporations can be divided into two categories: C Corporations and S Corporations. When they are formed, all corporations are counted as C Corporations. However, filing a form with the Internal Revenue Service can allow them to be taxed as an S Corporation instead.
- C Corporation Taxes – A C Corporation is subject to corporate income tax based on the company’s profit. Any shareholders that share this profit will have to pay personal income tax on that portion as well. Because of this “double dipping,” C Corporations and their shareholders can sometimes end up paying more in taxes than S Corporations or LLCs.
- S Corporation Taxes – S Corporations are known as “pass-through entities” because, instead of paying a corporate income tax, the corporation passes its profits down to the shareholder’s personal tax returns. This makes payment the shareholder’s responsibility. However, S Corporation status is unavailable to any company that has more than 100 shareholders or has more than one class of stock. The shareholders must also not be a part of any partnerships or corporations, nor can they be non-resident aliens.
Corporate Employment Tax
A person can be both a corporate shareholder and an employee so long as they own stock in the business that they work for. Half of the employee’s Medicare and Social Security taxes are paid for by the corporation while the other half is deducted from the shareholder-employee’s base salary. It’s also worth noting that Social Security and Medicare taxes do not apply to a shareholder’s profit distributions. A shareholder-employee can further reduce their taxes by taking more in distributions in exchange for a lower salary. Make sure that this “lower” salary isn’t anything too crazy – the IRS requires shareholder-employees to be paid a reasonable salary should the company wish to stay out of trouble.
Many business owners choose LLCs because of their great flexibility in terms of tax classification. Unlike corporations, an LLC does not have its own IRS tax classification and instead has these three options to choose from. The first two options involve filing with the IRS for either C-Corporation or S-Corporation style taxation. The third option is known as “disregarded entity taxation.” This status counts the LLC as if it were either a sole proprietorship or a partnership. This is the default taxation status of an LLC if you did not elect to be taxed as a corporation. Under this model, the company’s income and expenses are done through the owner’s personal tax forms – more specifically, schedule C of the LLC tax form.
A general overview on LLC taxes can be found here.
LLC Employment Tax
LLCs that are taxed like a corporation can treat their shareholder-workers as employees, and as such enjoy the same corporate employment tax benefits. Those taxed as disregarded entities, on the other hand, its working owners are regarded as self-employed. For income tax not exceeding $118,500, the owners must pay the 15.3% self-employment tax in full, as well as 2.9% for income above that cap.
Your taxation status is one of the most consequential decisions you will make for our business. This isn’t something that you can decide on over lunch or during your morning coffee. If you’re still unsure which option is best for you, you don’t have to go it alone. Consider hiring a local business attorney to go over the details of your operation with you so that you can decide how to best move forward.
Now that you know the basics, here’s a quick read on how LLCs and Corporations can help the self-employed with their taxes, too.
Looking to start a business or grow your current business? Contact FL Patel Law today by visiting our website or calling 727-279-5037.