LLC vs S Corp
LLCs and S corporations are two very popular entities with small businesses. In this article, we compare the LLC vs S corp to highlight their differences and similarities.
LLC vs S Corp
I practice in California, so I am going to tailor this discussion to California business law. If you live in another state, you can use this as a general educational guide, but should consult with an attorney in your area for specific advice. Business law is controlled by state law, and each state has different rules.
The question of an LLC vs S corp often seems an exercise in futility at first since the entities are often touted to be very similar. In truth, they are. Both provide protection from lawsuits and both have pass through tax status. To find the true differences, you have to look into the details. These details can make all the difference.
The first difference between the two has to do with formalities. The LLC is very informal. You need to comply with only a nominal amount of corporate formalities. Furthermore, you don't have to have payroll. This allows you to take draws when needed, which can help when it comes to cash flow situations. None of this is true for the S corporation. If your revenues are solid, it doesn't really matter. If they are not, it can make a big difference.
Taxes are the second area where there is a big difference. Both entities are pass through companies. This means the finances of the business pass through to the personal tax returns of the owners, which avoids the double taxation situation faced by C corporations. Ah, but there is one potential big advantage to the S corp over the LLC that can save you serious money.
Draws from an LLC are usually subject to self-employment tax of 15.3 percent. This is a sizeable tax that can really be a financial hurdle when tax time rolls around. Distributions from an S corporation work a bit differently. Simply put, they are not subject to the 15.3 rate, but are subject to FICA. However, FICA only applies to salary taken from the business. So long as you take a reasonable salary, you can take additional profits out as dividend and not pay FICA or self-employment tax on the money. This twist will save you thousands or tens of thousands of dollars depending on the profitability of the business.
Given the above, you might think jumping into an S corp is the obvious answer when picking an entity. Yes and no. The flexibility found in an LLC is a huge benefit and something that should not be undervalued. Being able to pull draws when you need to without any complications is often the difference between a small business owner making it or failing. If you are considering forming either a LLC or S corp in California, contact me at 619-637-6043.<< Back to Business Law Articles