You are the proud owner of a business and, like most, you set up shop via an LLC.
Recently, you’ve heard talk about S Corps being better, so now you’re wondering: should I become an S Corp?
Here are two questions to help you find your answer.
1. Are you paying yourself the same or more than you’d make in a “normal” job?
If you applied for jobs with similar responsibilities to what you’re doing in your own business, what base salary would you get? If you’re paying yourself that or more now, then go to the next question.
If you’re still pinching your own salary in order to reinvest revenue back into the business, stay an LLC.
2. Is your business revenue stable year-to-year?
It’s normal to have busy and slow seasons, but can you confidently ballpark what your revenue numbers will look like year-over-year?
If yes, then it’s a good time to switch to an S Corp. Check out our next article on how to do so.
If you’re still seeing quite a bit of revenue volatility as you build a stable client base, stay an LLC.
Overall
Almost all of our clients start out as LLCs. Once the business gets up to speed and is paying all owners fair market value for their labor, it’s advantageous to become an S Corp. S Corps are a good structure for medium-sized, privately held companies. If your goal is to continue building up your business and leading it for the foreseeable future, this is probably a good path for you.
S Corp FAQ
What’s the benefit of using an S Corp?
The primary benefit is bringing down your tax bill.
As the owner of an LLC, your business income flows through to your personal taxes. Your tax bracket is assessed based on your total income. On top of that, you pay a percentage into Social Security and Medicare.
With an S Corp, you pay yourself first as a salaried employee. That smaller amount will allow you to be assessed at a lower tax bracket. Also, while you still have to pay Social Security and Medicare taxes, half of it can be paid by the business rather than all of it being paid by you. The second way you pay yourself is with a distribution. This will be taxed at the capital gains rate, which is higher, but remember you're no longer paying self-employment tax on it, so you see a net savings.
Who can form an S Corp?
You need to be a U.S. citizen or resident.
An S Corp can’t be owned by another corporation, an LLC, or a partnership, so if you’re planning some Russian nesting doll legal structure, don’t go this route.
Why shouldn’t I use an S Corp?
S Corps are more rigid and have more administrative requirements than LLCs do. You need to have the systems and supports in place to handle that workload.
They also have stricter limitations on their use. You have to be a U.S. resident or citizen, the entity has to be domestic (operating within the U.S.), you can’t have more than 100 shareholders, and you can only issue one kind of stock.
What even is an S Corp anyway?
Take another sip of coffee.
An S Corp is an IRS designation. Remember that your LLC is created at the state level. Once you have your LLC, you can file a form with the IRS and request to be designated as an S Corp at the federal level. How your company is treated at the state level varies from state to state. Both LLCs and S Corps are pass-through entities. This means that gross profit goes to the owners and is reported on their personal tax returns.
Still have questions? Ask them. We'll answer.
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