Member of Russell Bedford International, a global network of independent professional service firms.
Member of Russell Bedford International, a global network of independent professional service firms.
Choosing the right business structure can make or break your bottom line as an entrepreneur. The decision to become an LLC or an S corporation can be confusing. In this episode of CK Small Business Focus, CK Tax Manager Eric Challenger breaks down how these two popular structures differ when it comes to taxes, liability protection and administrative complexity. Whether you’re just starting out or your business has grown past the point where self-employment taxes are eating into your profits, this episode will help you understand the pros, cons and key considerations of each option. Then you can decide which structure fits your business today and when it might be time to make a change.
Transcript:
Welcome everyone to another edition of the CK Small Business Focus. My name is Eric Challenger and I’m a Tax Manager at Cray Kaiser. Today we are going to be analyzing which structure, LLC or S corp, is best suited for your business.
Starting a new business comes with a long list of important decisions and one of the most crucial is selecting the right entity type. The two most common structures for small businesses are the limited liability company and the S corporation. Each offering unique benefits and drawbacks, understanding how these entities differ in terms of taxes, legal treatment, and administrative complexity can help you make the right decision as your business grows.
Let’s start with the LLC, the flexible starting point. An LLC is often the go-to legal structure for new entrepreneurs. It offers limited liability protection, meaning your personal assets are typically shielded from business debts and lawsuits. and allows for flexibility in ownership and income allocation. For tax purposes, the IRS doesn’t recognize an LLC as a distinct tax entity. Instead, a single-member LLC is treated as a disregarded entity with all activity reported on the owner’s individual tax return on Form Schedule C. A multi-member LLC is taxed as a partnership unless it elects to be treated as a corporation.
Simple tax filings for SM LLCs. Just report on your individual return. Flexible ownership and income allocations make it easy for you to allocate income to specific members.
Low administrative burden. Ideal for startups and low-profit operations. However, active owners of an LLC must pay self-employment taxes on the entire net income, which can be costly as the business grows.
Now let’s talk about S corporations. An S corporation isn’t a legal entity. It’s a tax election that an LLC or a C corporation can make with the IRS. Once elected, it changes how the business is taxed and allows owners to reduce their SE tax burden by splitting income into salary and distributions.
Payroll tax savings. Unlike the LLC, S corp owners can pay themselves a quote-unquote reasonable salary and take the rest of their income as distributions exempt from SE tax. Maximize qualified business income deduction. If structured correctly, you can take full advantage of the 20% QBI deduction introduced by the Tax Cuts and Jobs Act.
Lower audit risk. S-corporations file separate business tax returns reducing audit visibility compared to Schedule C filers.
Increased compliance. You’ll need to file payroll, issue W-2s, and submit a separate business return.
Reasonable compensation. Reasonable compensation is required, and the IRS scrutinizes this closely. State recognition varies. Some states may not recognize S corporation election and may impose additional tax filings, or you may have to file as a C corporation.
Electing S corp status makes the most sense when your business is generating net income significantly above your reasonable salary. While “reasonable” is subjective, many practitioners suggest considering an S corporation once your annual income exceeds $150,000. The tax savings from reduced SE taxes can often outweigh the added compliance costs from becoming an S corporation. But not every business is ready for that transition. If your income is modest or irregular, or if you value operational flexibility and minimal paperwork, the LLC structure may still be a better fit.
So the bottom line, your choice of business entity will shape your tax obligations, personal liability, even your ability to raise funds. While most businesses start as LLCs for simplicity, making the S corporation election can be a smart strategic move once you’re generating higher profits. Still unsure which path is right for you? The entity that suits your business today may not be the best option tomorrow. If you’re a single member LLC or a partnership looking to explore the tax benefits of electing S corporation status, reach out to the tax experts at CK for tailored advice at www.craykaiser.com or call us at 630-953-4900.
For more information, download our white paper.
