A $10,000 Reason To Have a Tax Plan

 

 

You may have been told in the past that there is very little difference between an S-Corp and an LLC. If you were one of many business owners told this, you may have been told wrong.  How wrong depends upon your business and your business’s profitability.  For many who run LLC’s, they’re paying 15.3% in self-employment taxes on significant earnings unnecessarily.

 

Here are the Facts:

LLC’s are pass through entities.  By default, an LLC is either taxed as a partnership (when there is more than one owner) or as a disregarded entity for tax purposes (single-owner) on schedule C of the owner’s 1040.

The problem is 100% of the ordinary profits of a partnership or a schedule C business are subject to self-employment tax.  Self-employment tax is nothing more than both the employer and employee side of FICA and Medicare taxes.  LLC owners pay 15.3% on all ordinary income from their business (up to $117,000 in 2014).

Alternatively, corporations and LLC’s who elect S-corporation status are treated differently.  Business owners are required to take a “Reasonable Wage” and the owner and their business pays the same 15.3% in payroll tax on those earnings.  However, the business’s ordinary income in excess of the reasonable wage is excluded from the self-employment tax calculation.

 

To Paint the Picture:

LLC Owner

Total

S-Corp Owner

Total

LLC Owner Earnings

  $  100,000

S-Corp Owner Earnings

   $ 100,000

Employment Tax

  $    15,300

Reasonable Wage

   $   40,000

 

 

Employment Tax

   $     6,120

 

 

Total Tax Savings

   $     9,180

 

 

Here’s the Punch Line:

LLC members pay employment tax on the entire net income of the business while the S-Corp shareholder will pay employment tax for their “reasonable wage.” S-Corp Shareholders however, are allowed additional profits from their business as distributions.  Distributions are not subject to self-employment taxes. 

 

You Can Fix This:

You can make an election for your LLC to be taxed as an s-corporation.  However, certain consequences of changing legal structure can be complex.  There are specific benefits and limitations to both S-Corp and LLC businesses not listed in this newsletter.  Discuss any election before making it with a tax professional.

GuideSource can offer you additional insight on this matter as well as many other matters regarding financial management. GuideSource can provide detailed differences between the different types of entities and how they impact your unique circumstances.


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