Morning All…

There are two major types of limited liability business… the Corporation and the LLC.  For most small businesses, you are going to be choosing between these two.  Specifically, for most small businesses the choice is between an S Corporation (which is just a regular corporation with one extra form filed one time) and an LLC.

It is Mainly a Tax Decision

I believe that this decision is primarily about potential tax savings. The information below may not be accurate for all states and situations, you need to figure this out yourself or with the help of your accountant and attorney if you don’t know what to do.  I am going to greatly simplify this decision below as it applies to many small one or two owner businesses…

The biggest drawback with an LLC is that, as an owner, you have to pay payroll taxes on all of the corporate profits, not just on salaries and wages.  This can be a significant amount of additional taxes that you pay with an LLC and was the main reason I went with the S corp.

Let’s look at an example to clarify this.  If we assume that the business is generating $200,000 in total income and total deductible business expenses of $100,000 then the net profit is $100,000.  With an LLC, you will report this as personal income and be required to pay payroll taxes on this entire amount.  

How Much Are Payroll Taxes?

Payroll taxes are the taxes that are paid on salaries to fund the government Social Security and Medicare programs.  The employee pays a certain amount towards each and the employer is required to match that same amount.  When you own your own business, you pay both parts, so it is double what you are used to seeing on a paystub. 

In 2008, the payroll tax calculation is 15.3% of the first $102,000 plus 2.9% of everything over $102,000.  The $102.000 number increases every year and in 2009 it will be $106,800. 

Going back to our example of $100,000 profits, the owner of the LLC would be required to pay $15,300 in payroll taxes on that $100,000. 

S Corporation Payroll Tax Savings?

So, an LLC generating $100k profits you pay $15,300 in payroll taxes.  How about an S Corp?  With an S Corp, you can pay the owners a reasonable salary for the job that they do.  And you pay the payroll taxes on this salary.  The rest of the profits are considered the income generated by the fact that you took the risk and invested the money to start the corporation and you pay income tax on this money but not payroll taxes. 

If we assume that you determine that a reasonable salary is $55,000 for your job then you will pay $4207.50 in payroll taxes, the corporation will also pay $4207.50 in payroll taxes for a total of $8,415 in total payroll taxes.

Remember that the LLC owner paid $15,300 in Payroll taxes. 

So, the S corp in this example saves you $6,885 per year in payroll taxes.  Assuming that you are going to be in business for a while, this can add up.  In under 15 years this is $100,000 savings.  And the payroll taxes just keep going up…

With these tax savings, why would anyone start an LLC instead?  Well, one reason is that if you are already maxing out your payroll tax contributions at a regular job, or in another business, then these tax savings are greatly reduced.  Here are few other factors…

Limitations and Requirements of an S Corp…

There are a few limitations on S corps which might affect some people:

□      Can’t have more than 100 shareholders

□      Can’t have foreign owners

□      Can’t be owned by other corporations or LLCs

□      S corp profits need to be distributed according to the percentage of ownership

And, S corporations require the owners to follow a bit more corporate formality… to “follow the corporate rules”.

It is not too big of a deal, once you understand the rules and have an easy to use system in place to stay ahead of the game.

My simple Cover Your Assets package is a Clear, Concise, Step-by-Step program to assist small business owners to know what to do and when to do it with regards to their corporate record keeping requirements.

Have a great day,

Rob