If you’re a business owner, your tax designation could be costing you more than necessary, especially for those that have grown in size since opening.

Since we understand designations, we’re sharing how they impact a business and why switching could be your best business move yet.

1. Tax Differences

Owners need to understand the basic tax differences between an LLC and an S-Corporation, even if switching isn’t something worth pursuing.

The main difference is that an LLC is a legal structure, whereas an S-Corporation is a tax designation. This allows owners to split earnings between a salary and distributions, which could result in a massive saving in self-employment tax when compared to an LLC that typically has its profits reported on an owner’s personal tax return.

2. Structure

The business structure for an LLC tends to be less rigid when compared to a corporation. For example, an LLC can be managed by its members, or appointed managers however it sees fit. But an S-corporation has a formal structure that it is required to follow, including things like shareholders, annual meetings, and company directors that all need to be involved in the decision-making.

3. Ownership and Capital

Another key difference between the two business structures is the way that capital and ownership are handled. An LLC allows its ‘members’ in on the profit-sharing, but S-corporation will have to issue stock to raise capital.

4. Ownership Restrictions

There are some types of professionals (for example, doctors, based on IRS stipulations) that may be legally required to form a corporation instead of an LLC. This rule is designed to enforce regulatory oversight, liability requirements, and ethical rules of the practice in specialized fields.

5. Maintenance

LLCs are generally easier to manage when it comes to day-to-day operations when compared to corporations. This is because they offer simple pass-through taxation and are not required to have any formal meetings before big decisions are made.

In comparison, corporations require strict record-keeping, annual meetings, and assessments, plus the implementation of bylaws. Failing to meet these compliance standards will result in massive fines or consequences, which is something to be considered.

6. Salary and Profit

Switching from an LLC to an S-Corporation tends to make more sense once a business makes a consistent net income (typically $50,000 or more). Any company bringing in less than this amount may want to reconsider the swap, as the administrative and legal fees to do so will likely outweigh the benefits.

The IRS also requires S-corp owners to pay themselves a “reasonable salary.” If it’s not “reasonable,” you could find yourself in hot water with the IRS.

We recommend that every owner thinking of making the swap speak to a professional like us at A.P. Accounting & Tax Services. We’ll be able to assess your current situation to see if making the switch is the right move.

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