Here are a few things to take into consideration:
In an LLC, the money you take out of your LLC as a member is called an Owner’s Draw.
You draw money out of the business without paying payroll taxes, so you do not need to remit quarterly payroll taxes, and you do not need to use payroll providers such as ADP, Gusto, Justworks, etc. We recommend that you never do your payroll by yourself!
Before you get too excited, keep in mind that you still have to pay taxes, called self-employed taxes, and they are calculated on your total profit when you file your tax return and not just what you take out of your business bank account. The good news is that if you have no profit, you will not pay any self-employed taxes even if you took money out of the business. Note that a draw is not an expense; therefore it does not reduce your profit.
In 2018, the self-employed tax rate is 15.3% (12.4% for social security and 2.9% for Medicare taxes). The IRS allows you to deduct 7.65% from your self-employment income before applying the 15.3% self-employed tax rate.
To illustrate, let’s say your net earnings are $100,000. The self-employed tax will apply to $92,350 and amount to $14,129.55 ($92,350 x 15.3%).
Apart from the above savings, you would report one-half of your self-employed tax, $7,064.78, ($14,129.55 X .50) as an adjustment to income on Individual tax return Form 1040, which would reduce the amount of income tax you owe.
As a self-employed person, you also have to pay quarterly estimated taxes to the IRS. Your prior year taxable income will be used to calculate your quarterly estimated taxes. If anything has changed during the year, talk to your accountant so the calculations can be adjusted.
In a corporation, to take money out of the business, you have to pay yourself a salary and pay payroll taxes, unemployment insurance and workers compensation insurance (note that S Corporation status allows to avoid the workers’ compensation for officers in most states). The payroll taxes are composed of employee taxes which are withheld directly from your paycheck and employer’s taxes, also debited every time you process a payroll and remitted to the state and Federal tax authorities on a quarterly basis by your payroll provider.
In addition to these taxes, you also have to pay the payroll provider for the processing fees. As an example, Gusto charges $39 per processed payroll + $6 per employee every time a payroll is processed. Note that you cannot pay yourself only a dividend. By law you are required to pay yourself a salary before you make yourself a dividend distribution.
The employee and employer taxes combined amount to 15.6%. I know what you are thinking now: “Wait, isn’t it is the same rate as self-employed taxes?” Yes, but in an LLC you pay self-employed taxes on the total profit (the taxable profit i.e. adjusted income after business deductions), whereas in a corporation you pay payroll taxes only on the money you take out.
Again, I know again what you are thinking: “Well, in that case a corporation is much better than an LLC!”
Tax treatments of each
Not so quick! There are lots of other considerations that you need to take into account.
The most important one is the taxation of the entity. An LLC is a pass-through entity, which means that if it incurs a loss, this loss will reduce your taxable income from your personal return in case you have received income from another source.
In a corporation, you will have to pay corporate income taxes on the profits of the corporation. Individual shareholders pay income taxes on the dividends received from the corporation; this is why the corporation is known to have a “double taxation” effect. This situation can be avoided if the corporation does not make profits and does not distribute any dividends.
An LLC does not require you to maintain a corporate book with Board Minutes and Meetings. However, this should not discourage you to pick a corporation if you think it is a better fit for you. You can do this by yourself thanks to Nolo guides which make the process easy for you, or you can have a lawyer do it for you.
If you have no clue on which one to pick and you know that you will never do an IPO, an LLC can be a good choice because you can later choose a different tax treatment. An LLC might be a good option when you start your business and starting to have lots of excess profit. You can decide to have your LLC treated like a corporation for tax purposes by filing IRS Form 8832, Entity Classification Election, and checking the corporate tax treatment box on the form. And, once it is elected to be taxed as a corporation, an LLC can file a Form 2553, Election by a Small Business Corporation, to elect tax treatment as an S-corporation (unless you are a non-resident alien, in that case you would have to stick to the C corporation structure). This process of electing a different tax treatment cannot be done anytime so make sure you know the deadlines.
Having an LLC with a tax treatment of a corporation allows you to have the tax benefits of a C-corporation or S-corporation without the legal paperwork of a corporate book to maintain.
Both LLC and corporation allow you to protect your personal assets from the creditors of your business.
If you’re not sure whether an LLC or Corporation is right for you, the team at Nipren can help. Contact us today to discuss your particular situation.