TAX NEWS - June 2010
A: On the surface, the two entities — which are both popular choices for small-business owners — appear similar. Both provide liability protection while allowing profits to pass through to the owners' personal tax returns. That makes an LLC or S corporation markedly different from a regular or C corporation, an entity that is completely separate from its owners and reports its own taxes.
Because they're pass-through structures, LLCs and S corporations similarly prevent the so-called double taxation of profits. With a C corporation, profits are taxed twice, once at the corporate level and then again when distributed to owners at their own individual income-tax rates.
But when it comes to payroll taxes, "the S corporation is the hands-down winner," says Michael T. Hanley, a managing partner with Merl & Hanley LLP, an accounting firm in Smithtown, N.Y.
Here's why: An owner of an S corporation can distinguish between salary, which is subject to payroll taxes, and corporate profits, which are not. For instance, a single owner of an S corporation that makes $100,000 in profits might take a salary of $60,000, paying payroll tax for Social Security and Medicare (plus other applicable taxes) on just that amount. The $40,000 balance would still be subject to income tax — but not payroll tax. In contrast, an owner of an LLC would have to pay income and self-employment taxes — the equivalent of payroll taxes — on the entire $100,000.
Keep in mind, the IRS is well aware that owners of S corporations are tempted to underreport salary to avoid payroll taxes; a salary must be reasonable with comparable positions in the field. Sites such as Salary.com and GlassDoor.com provide salary information for various industries, or your accountant may have an idea of typical pay in your line of work.
Tax treatment isn't the only reason to choose an entity, and the LLC can in some cases offer greater protection of business assets and operational freedom. Check with a lawyer or an accountant about which is best for your business.