S Corp vs LLC – Tax Benefits Chicago Illinois

Updated July 1, 2015
Many new clients will ask me the benefits between S Corp vs LLC. The primary issue in entity choice is a legal decision, which means that this is something that you should be talking to your attorney about. I cannot discuss any legal implications, not being an attorney. But I can discuss the taxation differences.
The main problem from a taxation standpoint, is that an LLC is basically a partnership. And partnerships, like sole proprietorships, are set up to pay the maximum amount of tax legally allowable by law for an active trade of business in the United States. You are required to pay both income and self employment tax on all of your income. This problem is normally most apparent to lower and middle income tax payers.
The problem is that income and self employment taxes do not work the same way. Income taxes start at 10% and go up to 39.6% for taxpayers earning in excess of $464K on a Married Filing Joint Return. In other words it is a sliding scale, with higher income individuals paying a larger percentage.
Self employment taxes are a flat tax of 15.3% in 2014 on the first $117,000 in self employment income. Many lower to middle income taxpayers pay more in self employment tax on their 1040’s than they do in income tax because it is not a sliding scale.
S Corporation income is not subject to self employment tax because a corporation is never going to turn age 65 and ask for social security and medicare benefits. Stop. Take a moment. Think about that. The entity choice itself determines whether or not you will have to pay the additional 15.3% tax. That is not to say under any circumstances that if you change your entity status from an LLC to an S-Status you can get out of paying social security taxes.
The Reasonableness Test
I could go through a lot of history on the story behind the Rev. Proc., but it all comes down to this. The owner of a profitable S-Corp must take out a reasonable salary and pay the appropriate social security and medicare taxes. The key word here is reasonable. If you are sick or hurt and can’t work, what would it cost you to replace yourself? If you could hire a manager to do your job for $50,000 a year and you have $110,000 in earnings from your S-Corp, then you just saved payroll taxes on $60,000. You take out a $50,000 W-2 for yourself, pay the appropriate payroll tax, and save the payroll tax on the additional $60,000 which would be over $9,000 in savings annually.
Again, the main decision between entity choice is a legal decision. Protecting yourself from all of the legal issues that can occur over the life of your business, is very important. But saving money is important as well. When I sit down with a middle aged business owner and show them how they can save five or ten thousand dollars a year in payroll taxes, that means important things to them like retirement savings, college funding, or a dream vacation. It also probably means that they have a current accountant that should be replaced.
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Chris Amundson is the President of Accounting Solutions Ltd., a full service public accounting firm of Certified Public Accountants and Enrolled Agents handling the bookkeeping, accounting, tax preparation, and audit representation needs of Businesses, Estates, Trusts, and Upper Income Individuals.