LLC vs. S-Corp: Which Structure Saves More Tax?

Choosing the right legal structure for your business is a pivotal financial decision. While both Limited Liability Companies (LLCs) and S-Corporations (S-Corps) offer liability protection and pass-through taxation, their tax implications differ significantly. Understanding these differences is key to determining which structure may save you more tax.

Tax Overview: The Core Similarities

Both LLCs (by default) and S-Corporations are pass-through entities. This means the business itself does not pay federal income tax. Instead, profits and losses "pass through" to the owners’ personal tax returns, avoiding the double taxation faced by C-Corporations.

Key Tax Differences: Where Savings Emerge

1. Self-Employment Tax

This is often the most significant tax differentiator.

LLC (Single-Member or Partnership): All business profit is subject to self-employment tax (15.3% for Social Security and Medicare, on top of income tax).

S-Corp: The owner must be paid a "reasonable salary" as a W-2 employee. Only this salary is subject to payroll taxes (the equivalent of self-employment tax). Any remaining profit distributed as dividends is not subject to self-employment tax.

Potential S-Corp Savings: This can create substantial tax savings, especially as business profit grows. However, the IRS mandates a "reasonable salary," and the cost of payroll processing and additional tax filings must be factored in.

2. Flexibility in Profit & Loss Allocation

LLC (Multi-Member): Offers great flexibility. Members can agree to allocate profits and losses in different percentages than their ownership stakes.

S-Corp: Profits and losses must be allocated strictly in proportion to each shareholder's ownership percentage.

3. Administrative & Compliance Complexity

LLC: Generally simpler, with fewer ongoing formalities and no requirement for formal meetings or minutes.

S-Corp: Requires more formality, including adopting bylaws, holding shareholder meetings, and filing an annual Form 1120-S. It also requires establishing and running payroll for owner-employees.

Which Structure Saves More Tax? A Decision Framework

An LLC may be the simpler, more suitable choice if you:

• Are a new or smaller business with modest profits.
• Value maximum flexibility and minimal administrative hassle.
• Have profits where a "reasonable salary" would absorb most of the income, negating S-Corp savings.

An S-Corp becomes a compelling option for tax savings when:

• Your business generates consistent, significant profit beyond what can be considered a reasonable salary for your role.
• The self-employment tax savings on the dividend portion of your income outweigh the added costs of payroll administration and compliance.
• You are willing to manage the additional corporate formalities.

Illustrative Example: If your business nets $100,000 and a reasonable salary for your work is $70,000, an S-Corp could save you self-employment taxes on the remaining $30,000 of profit. For an LLC, the entire $100,000 is subject to self-employment tax.

Important Considerations

State Taxes: Rules for LLCs and S-Corps vary by state (e.g., franchise taxes, entity-level taxes).

Future Goals: Consider investor needs or exit strategies. S-Corps have restrictions on shareholders (must be U.S. residents, limited to 100 shareholders, one class of stock).

It's Not Permanent: You can elect to tax an LLC as an S-Corp by filing IRS Form 2553, offering a pathway to change structures as your business grows.

The Bottom Line

There is no one-size-fits-all answer. An S-Corp can offer meaningful tax savings for established, profitable businesses, but it comes with complexity. An LLC provides simplicity and protection for most small businesses starting out.

Don't navigate this critical choice alone. The team at Prestivo Tax LLC can analyze your specific profit projections, industry, and long-term goals to provide a personalized recommendation on the most tax-efficient structure for your success.