What Business Type Do I Need For My Small Business?
If you're thinking about starting a new business, one of the first choices you will have to make is the type of business that works best for you. For a small business, you basically only have two viable options: an LLC or an S-Corp (a corporation governed by subchapter S of the IRS tax code). Both are pass-through entities, which means the members or shareholders are personally responsible for paying tax on money received.:
An LLC is simple and cheap to maintain. If your business makes less than about $30,000 to $40,000 in net profit, then you probably need an LLC.
Advantages to an LLC:
Disadvantages to an LLC:
An S-Corp is a more complicated business setup. If your business makes more than about $30,000 to $40,000, then you probably need an S-Corp.
Advantages to an S-Corp:
If you own 5% or more of your company, you are considered an employee and you can decide, within reason, what portion of your net income is to be allocated as your salary. This money is taxed for both income and self-employment, just like an LLC.
However, the rest of the net income is not subject to self-employment tax. This money may be kept in the company or may be paid out as shareholder drawings.:
When allocating net income, keep in mind that your retirement benefits such as Social Security, IRAs, and 401Ks are based only on the salary portion of your income. Also, you get a tax deduction for IRAs and 401Ks, making them even more beneficial.
Also, you can’t just allocate $0 for your salary to avoid self-employment tax. You have to allocate a reasonable salary in case the IRS audits you for some other reason and looks at your salary allocation. The allocation can be based on what a regular employee would make for 40 hours per week.
Disadvantages to an S-Corp:
A sole proprietorship is the same thing as a one-person LLC as far as filing taxes goes, but the LLC’s limited liability makes it the preferred choice in most cases.
A C-Corp is usually not a good choice for a small business because it uses double taxation. Income is taxed at both the corporate level and the shareholder level. An LLC or an S-Corp uses single taxation. Profit, loss, deductions, and credit are passed on to the members or shareholder for tax purposes and income is not taxed at the LLC or corporate level.