Feature:
LLC or S-Corp: Which Entity Type is Best for Your Business?

Many business owners begin their company as an LLC at the advice of a professional or just because of the relative simplicity of creating this type of entity. (In the state of Georgia, you can access all of the forms you need at the www.sos.state.ga.us.) As your business grows in size and complexity, there may be benefits to changing the way your business is organized for both legal and tax purpose.

Individual business owners typically set up an LLC so they can form a separate tax entity from themselves and to create personal asset protection. For tax purposes, a single member LLC is treated as a sole proprietorship. An LLC with more than one member is treated as a partnership.

In the event of realized income to the partnership or the sole proprietorship, self employment tax is due on the net income.

When you were an employee of another company, 7.65% of your salary was withheld as employment tax for your contribution to social security and Medicare (FICA). Your employer paid a matching 7.65% contribution.

Now that you own your own business, you are required to pay both halves of the FICA tax or the full 15.3%. Suddenly being self-employed doesn’t sound so profitable, eh?

There is a solution. You may elect to have your business treated as a small business under sub-chapter S of the corporate tax code. As long as the owner of an s-corporation pays themselves what is deemed a reasonable salary, the net income after that salary is not subject to the FICA or FICA match -- it is only subject to federal and state income taxes. As a result of this strategy, you will only be required to pay the 15.3% employment tax on the w-2 income that you receive from your company as a salary.

FOR EXAMPLE
Assume your company had a $100,000 profit. An LLC (sole proprietorship or partnership) is going to be subject to $15,300 of self employment tax. However, if you give yourself a salary of $50,000, then your FICA and FICA match tab would be only $7650 and you could return the $7650 that you saved to the cash flow of your business.

So how do you take advantage of these savings if you already have an LLC?

First, talk to your attorney about converting your LLC into an s-corporation. There may be some additional benefits for your company in doing so, beyond simply the tax advantages.

Then talk to your CPA or Income Tax Advisor about filing as an s-corporation using the 8832 entity classification. He or she may suggest that you make some changes in your record keeping in order to facilitate use of this form and should be able to advise you of the possible savings.

David D. Mobley, Jr. CPA is a partner in the public accounting firm of Mobley & Company. You can reach David at dmobley@mobleyandcompany.com.

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