The Benefits of the S Corporation
Most small business owners can benefit by electing to be taxed as an S corporation. The taxpayer pays themselves a portion of their business net earnings as payroll and the remaining amount is distributed as passive income not subject to SE tax, which can result in spectacular tax savings. It also has a significantly lower audit rate when compared to the Sole Proprietorship.
On the other hand, it is a complex entity that requires more sophisticated accounting, which results in higher professional fees; nevertheless, the entity is almost always a win-win for the business owner, as well as their accountant.
S Corporation Cautions
Without professional accounting involvement during a down turned economy S Corporations can be tragic.
Owners of S Corporations are required to pay themselves payroll, as well as take distributions. During good years businesses tend to be more lucrative, therefore accountants will advise their clients to draw more money as payroll, generating payroll tax liabilities.
Without council business owners might believe that their payroll must be paid even to the detriment of the business. Some business owners will take personal loans and inject them into the business to pay their own payroll and payroll taxes.
Often business in a down turned economy won’t have the funds to pay their own payroll taxes.Not paying payroll taxes is perhaps the most egregious crime committed by taxpayers in the eyes of the IRS.
The IRS assesses the most penalties and interest on outstanding payroll taxes, and per-sues payment aggressively.
LLC vs S Corporations?
This is a question comparing apples and oranges.
Business owners often form LLCs without fully understanding the tax implications. The tax implications of forming an LLC are that there are no tax implications. An LLC is a state administered designation and is not considered a tax entity by the IRS.
An LLC can be taxed as a Disregarded Entity/Sole Proprietorship, Partnership, or S Corporation. Therefore, a business can be an LLC and be considered (taxed) as an S Corporation by the IRS!
The Benefits of the LLC
The benefits of the LLC are that they are easy to form, they do not require bylaws or an operating agreement; they do not require minutes. They are exempt from many state unemployment programs (i.e no state unemployment tax).
Finally, the election to be taxed as an S Corporation can be elected retroactively to either the date the LLC was filed for or up to three years whichever was more recent.
What is Self-Employment Tax?
Most new business owners are not prepared to pay Self Employment Tax.
Many new business owners are blind-sided by their tax liability the first year their business is profitable. Often business owners will give up doing business for themselves due to being mired in tax debt almost solely due to the Self Employment (SE) Tax.
The SE tax replaces for a business owner the combination of employment tax that an employee has deducted from their paychecks for Medicare & Social Security tax (FICA), as well as the employer portion of Medicare & Social Security tax.
When a taxpayer owns a business that is also not incorporated they are expected to pay both the employee and employer taxes on their business net income as Self Employment Tax.
Not only is Self Employment tax a whopping 15.3% of net business income SE tax is not reduced by any other deductions or credits; if a taxpayer’s taxable income, after deductions, is zero, the taxpayer still must pay SE Tax.