It is no secret that as a new business owner of a startup faces many challenges. Not only do you have to have a competitive advantage with your offering, but there are also a range of legal obligations to adhere to, which includes financial regulations, employment laws, and tax responsibilities.   As a startup, it is crucial, and arguably the most important step, to figure out how you will organize the legal structure for your company. This choice will not only have an impact on how much you pay in taxes, but it will also affect the amount of paperwork your business is required to complete, the personal liability you face, and your ability to raise funds.

According to TRUiC, a limited liability company (LLC) is the type of business structure most small business startups choose, and an S corp is then elected to your LLC. In this article LLC vs S corp will be explained and discussed. Both LLCs and S corps benefit from a provision in the Tax Cuts and Jobs Act of 2017 that allows qualifying owners of pass-through entities to deduct 20% of qualified business income (QBI) from their tax returns however, the deductions do not apply to profits paid out as wages for S corp.

To Get Started: The Difference between LLC and S Corp

LLC stands for limited liability company and is a type of business structure that company owners can use to protect their personal assets; and allows for one or more partners, owners, or “members”. This solution is used in different states.  An LLC can elect an S corp which is an IRS tax status, and under an S corp, business owners can save around 17% in taxes if they comply with a few statements and regulations. If the business can pay the owner(s) a “reasonable salary” every year; along with a positive return on investment for payroll service and accounting costs associated with running an S corp, and there are substantial distributions annually at a minimum of about $10,000. If the startup meets these S corp requirements it can then be classified as financially viable.

There is another option most small businesses tend to lean towards, namely the LLC “default” which is the more desirable choice if your startup doesn’t have the amount of net profit needed to benefit from an S corp. This would also be more advantageous if you are unsure how much net profit your business will earn on an annual basis, and you plan to reinvest most of the company profits to grow the business. With regards to FICA, a default LLC will pay income tax and FICA on any profit and distributions whilst the owner of an S corp will pay income tax and FICA on salary and distributions are only subject to income tax.

An S corp owner will only pay FICA and income taxes on their salary and only income taxes on distributions, instead of paying self-employment tax and income tax on all distributions from the business. Setting up your enterprise this way could lead to beneficial tax savings under the right circumstances.

S corp election: How it can benefit your startups’ profit and distribution

In the form of salary and distributions, electing an S corp will allow a small business owner to disburse an LLC’s profit to the owner and employees. It can be costly to elect and maintain an S corp where filing fees with the IRS are minimal, however, the additional bookkeeping and payroll costs are not, and for LLCs, who already have employees and payroll costs, this factor won’t hold as much weight.

As a business owner of a startup, one should weigh the cost of maintaining these services against the fiscal tax advantage of electing the S corp classification.

Set Up a Business Bank Account

In order to avoid piercing the corporate veil, it is necessary for you as an entrepreneur to build business credit, which means that for both S corps and LLCs you will need a separate bank account in order to separate your business expenses from personal expenses.

Final Take

Launching a startup in America is a process many entrepreneurs embark on, and there are few legal challenges to overcome when getting your business off the ground, but making the right decisions regarding the business structure can substantially influence how you and your business are protected. Choosing an LLC business structure would ultimately protect you from personal liability under most circumstances and by electing an S corp for tax designation, the owners of the enterprise are considered employees of their company and can therefore save thousands of dollars on self-employment taxes as a result.

 

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