Sole Proprietor vs LLC vs S Corp: Which Entity is BEST for Business Taxes?

which business entity is going to save you the most money on your taxes a sole proprietorship llc s corporation or c corporation now your tax expense can vary greatly based on the entity you select here and by greatly i mean thousands if not tens of thousands of dollars by the end of this video i hope that you're saving thousands and not paying thousands more than you have to in taxes [Music] everyone my name is sherman i'm a cpa here at life accounting where we help businesses manage money and save money in their business today i'm going to help you select the best entity for your business this information is information that we typically charge for as a part of our tax planning service but today you get this information for completely free and for more free content to help you save more money in your business be sure to like this video and subscribe to our channel with that said let's begin when it comes to entity selection there are legal entity types and there are tax entity types a legal entity is an entity that you register with your state and your tax entity is the entity that you elect to file as with the irs for example you can register your business as an llc with your state for legal purposes but elect to be taxed as an s-corp with the irs for tax purposes meanwhile for legal entities there is no such thing as an s-corp we'll discuss this in each type of entity in a moment but before we do this it's important that you understand the taxes that are involved for all entities so let's talk about pass-through entities the first thing you need to understand about entity taxation is pass through taxation sole proprietors partnerships llcs and s-corporations are taxed as pass-through entities this means that all income your business receives passes through to you personally for tax purposes for example if your business made 100 000 and you owned 100 of that business then you will be required to pay taxes on that 100 000 individually not as a business the exact tax you pay on that will depend on the tax bracket your total personal income falls in and then there's something called double taxation only c corporations are subject to double taxation double taxation is where the company itself is taxed on all of its profits before payments to owners are made and when those payments to owners are made the owners are then taxed on the payments they receive from the corporation so you're taxed twice because of double taxation c corporations are not the most popular choice amongst small businesses so let's discuss a major tax that most small businesses encounter as pass through entities and that is the self-employment tax self-employment tax is currently an extra 15.3 percent tax on your income it's basically the government's way of funding programs like social security and medicare which is normally deducted from your paycheck as an employee only difference is as a business owner you're paying both the employer portion and the employee portion of the tax equaling a total tax of 15.3 percent now here's the thing you need to know about self-employment tax self-employment tax does not currently apply to s-corporations or c corporations and because c corporations are subject to double taxation and s corporations are not it shines a bright light on s corporations as a good entity choice to save on this type of tax still s-corps are subject to some different rules that may complicate this so let's look at each entity closely so you can determine which makes the most sense for your business number one sole proprietorships in general partnerships if you do not register your business with your state then you are a sole proprietor by default for example if you woke up tomorrow and start cutting people's lawns in exchange for money then you will be doing business as a sole proprietor and if you and your friend decided to work together to do this then you would be a general partnership sole proprietors and partnerships are both taxed the same they just foul in different places on their tax return sole proprietors report their business income on their individual tax return or 1040 and they use schedule c to report the business income or loss from their business partnerships report business income on their partnership tax return or 1065. each partner must receive a k1 which basically reports what portion of the profits they are entitled to both entities can deduct business expenses to lower their income you can deduct things like your advertising expenses car expenses office expenses and much more on your return now the major taxes they are subject to are federal income tax state income tax and self-employment tax on the legal side the most unattractive thing about sole proprietors and partnerships is that they carry substantial risk the biggest legal risk is that you have no protection of your assets for example if you accidentally set your client's house on fire then you'd be personally liable for all the damages that means that if they sued you they could go after everything you own to prevent this most people decide to organize themselves as a llc so let's talk about it number two a limited liability company a limited liability company or llc does exactly what his name says it limits your liability for your company by default there is no extra tax benefit of registering your business as a llc it just protects you so in the same example if you accidentally set your client's house on fire then you will not be personally liable if they sued you only your company will be liable which means your loss will not exceed the amount you've invested into your company for this reason llcs is one of the most popular entity types amongst small businesses they provide strong protection and are very easy to set up now on the tax side the forms you file are different based on if you're a single member llc or a multi-member llc single member llcs file their taxes on a schedule c just like sole proprietors and multi-member llcs file their taxes on a 1065 just like partners now here's the interesting thing as an llc you can elect to fail as an s-corporation for tax purposes this would allow you to tap into the tax benefits of a s-corporation without having to form a corporation so number three let's talk about s-corporations s corporation is a special tax status granted by the irs that lets corporations avoid double taxation and pass their income through to their shareholders like partnerships to be clear an s corporation is not a legal entity you must have a legal entity in order to elect s-corp status for example llcs nc corporations can elect to be treated as a s-corporation for tax purposes you must be a domestic corporation with no more than 100 shareholders to become eligible for s-corp status and in order to elect s-corp status you must file a 2253 form with the irs if accepted then you would file an 1120s as an s corporation on your tax return this means that you would not be required to pay self-employment taxes this is great but there is one major rule the owners of s corporations must pay themselves what is called a reasonable salary for the work they do in their business before receiving distributions of profits this reasonable salary must be paid like you would pay a w2 employee which also means that you are still paying medicare and social security taxes to some extent in order to do this you must first set up a payroll system to pay yourself and submit quarterly payroll taxes and you also have to figure out how to pay yourself a reasonable salary now the irs provides some factors for you to consider like your training and experience or what you would pay a non-shareholder employee to do the same job but still the answer can still be a little unclear and if you get this wrong the irs can go back and reclassify payments listed as distributions as w2 wages that you must then pay taxes on now this transparently intimidates a lot of business owners but according to many cpas i know the unofficial rule that they go by is that a reasonable salary to pay yourself is equal to about one-third of the business profits so as long as you're doing this as an s-corp i'd say you should be fine many people who are getting caught up with the irs apparently aren't paying themselves any salary at all now here's the good news by setting a reasonable salary you effectively limit your exposure to self-employment taxes for example let's say you made one hundred thousand dollars in income and paid yourself seventy thousand dollars as a reasonable salary in that case you'd only pay social security and medicare taxes on the seventy thousand dollars and would not pay it on the difference of thirty thousand dollars and for you math numbers out there thirty thousand dollars times fifteen percent equals forty five hundred dollars that's forty five hundred dollars in tax savings just from choosing the right entity so anyway which entity is best for you ultimately the best entity for you will depend on where you are in your business but here are some very general recommendations that i can give you when you're just getting started consider starting off as an llc it's super easy to set up and will provide you limited liability for your business once you start making over fifty thousand dollars per year in business income then you may want to consider electing s-corporation status this will limit your exposure to self-employment taxes as you continue to grow your business all right folks i hope that helped you all that's it for today's episode and if this video helped you please let me know by hitting that like button below i'll see you in the next episode you

Channel: LYFE Accounting

Views: 32,588

Keywords: Sole Proprietor vs LLC vs S Corp, Sole proprietor vs LLC, llc vs s corp, Best Business Entity, Entity taxation, How Business Taxes Work, Business Taxes

Id: Rc-WbqCCOFU

Length: 11min 16sec (676 seconds)

Published: Wed Mar 03 2021