Corporation or LLC?
Corporation or LLC?
The majority of small businesses operate as S corporations. An S corporation is a regular corporation that has made a special election with the IRS in order to avoid the double taxation associated with regular C corporations.
Because of self-employment taxes associated with LLCs, they are recommended only in certain situations:
Businesses operated or invested in by non US residents
Real estate ventures with anticipated revenues less than $250,000; or
Businesses with other entities (corporations, LLCs, trusts, estates) as investors.
A corporation is a taxpayer in its own right, separate and distinct from its shareholders, and is taxed at the corporate tax rate. The individual shareholders are also taxed on dividends received from the corporation with no corresponding deduction to the corporation. This results in double taxation (the same money is taxed twice). This double taxation may be minimized by the payment of salaries to shareholders and by the use of shareholder loans. However, corporations issuing excessive or unreasonable salaries to their shareholders often face penalties from the IRS.
All corporations formed by default are “C” corporations. A C corporation is a corporation that has not made an election to be an “S” corporation. The term C corporation is specifically used because the entity is taxed under subsection C of the IRS code. C corporations are taxed at two levels (“double taxation”). This means that the corporation itself pays its own tax when it makes money (the first tax). The owners or shareholders are then taxed again when they are paid a salary or dividend by the corporation (the second tax). Despite double taxation, C corporations offer many planning and benefit opportunities. For example, a C corporation can be used to accumulate assets or wealth at corporate tax rates, which are lower than the individual tax rates.
Self-employment (SE) tax is a 15.3% tax on income. This rate, 15.3%, is a total of 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).Normally these taxes are withheld by your employer. However, if you are self employed, it is your responsibility to pay them yourself. The SE tax rate for business owners is 15.3% tax of the first $90,000 of income and 2.9% of everything over $90,000. S corporations have a significant advantage when it comes to the payment of SE taxes. In an S corporation, only the salary paid to the employee-owner is subject to employment tax. The remaining income that is paid as a distribution is not subject to SE tax under IRS rules. Owners of LLCs, partnerships and sole proprietorships, however, pay SE tax on their respective share of profits rather than salary. Certain types of LLC income, however, are not subject to self-employment tax. For example, rentals from real estate and capital gains are not considered to be self-employment income, so real estate LLCs often need not be concerned with self-employment tax.