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I have been doing much research before deciding on a S-Corp or LLC for an online start-up (2 people, software as a service). I've read lots of explanations of the two and their differences and I've gotten much conflicting advice from start-up owners to CPAs:

"Go with LLC, the tax savings isn't worth the hassle!"

"Go with S-Corp; Given the self-employment tax savings, I don't know why anyone would choose LLC!"

Many people talk about the S-Corp savings on self-employment tax, but I wanted to actually crunch the numbers to see how much of a savings we'd be talking here.

Assuming the company makes 50k after expenses, is the following (rough) formula correct?

**LLC**
50k x 30% personal taxes 
= 15k taxes a year


**S-Corp**    
25k Salary x 30% (15% personal taxes and 15% paid by the company) 
25k Earnings x 15% you
(+ more accountant fees, payroll, red tape)
= 11.25k taxes a year
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2 Answers 2

FICA/SE taxes are not 30%. They are at most ~15%, including the employer portion. Employer also pays FUTA tax, and has additional payroll expenses (like fees and worker compensation insurance).

The employee's FICA portion is limited up to a certain level of earnings (110100 this year, IIRC). Above it you only pay medicare taxes, not social security.

S-Corp earnings are not taxed at 15%, these are not dividends. They're taxed at your ordinary income rate. You don't pay SE taxes on it, that's the only difference.

I hope you're talking about tax treatment decision, because there are entirely different factors to keep in mind when you're organizing a business and making a decision between being it a LLC or a corporation.

I believe you should pay some money to get a real advice that would apply to you, from a EA/CPA who would be doing the number-crunching (hopefully correctly).

I'm a tax practitioner, and this answer was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.

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Given your input, is this updated formula closer to accurate? LLC: 50k x 30%.... S-Corp: (25k Salary x 15%) + (25k Earnings x Your income tax rate) –  Susan Jul 9 '12 at 18:50
    
@Susan, no its not. You pay your income taxes on the LLC income as well. The only difference is the treatment of earnings that are not salary, with respect to the FICA taxes. For 50K split between two people that might not be a big difference at all. Remember, you have to pay a reasonable salary for yourself (and your partner), which in SW development may be pretty high. –  littleadv Jul 9 '12 at 18:55
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It might be best to step back and look at the core information first. You're evaluating an LLC vs a Corporation (both corporate entities). Both have one or more members, and both are seen similarly (emphasis on SIMILAR here, they're not all the same) to the IRS. Specifically, LLC's can opt for a pass-through tax system, basically seen by the IRS the same way an S-Corp is.

Put another way, you can be taxed as a corporate entity, or it's P/L statements can "flow through" to your personal taxes. When you opt for a flow-through, the business files and you get a separate schedule to tie into your taxes. You should also look at filing a business expense schedule (Schedule C) on your taxes to claim legitimate business expenses (good reference point here).

While there are several differences (see this, and this, and this) between these entities, the best determination on which structure is best for you is usually if you have full time employ while you're running the business. S corps limit shares, shareholders and some deductions, but taxes are only paid by the shareholders. C corps have employees, no restrictions on types or number of stock, and no restrictions on the number of shareholders. However, this means you would become an employee of your business (you have to draw monies from somewhere) and would be subject to paying taxes on your income, both as an individual, and as a business (employment taxes such as Social Security, Medicare, etc).

From the broad view of the IRS, in most cases an LLC and a Corp are the same type of entity (tax wise). In fact, most of the differences between LLCs and Corps occur in how Profits/losses are distributed between members (LLCs are arbitrary to a point, and Corps base this on shares).

Back to your question

IMHO, you should opt for an LLC. This allows you to work out a partnership with your co-worker, and allows you to disburse funds in a more flexible manner. From Wikipedia :

A limited liability company with multiple members that elects to be taxed as partnership may specially allocate the members' distributive share of income, gain, loss, deduction, or credit via the company operating agreement on a basis other than the ownership percentage of each member so long as the rules contained in Treasury Regulation (26 CFR) 1.704-1 are met. S corporations may not specially allocate profits, losses and other tax items under US tax law.

Hope this helps, please do let me know if you have further questions. As always, this is not legal or tax advice, just what I've learned in setting several LLCs and Corporate structures up over the years.

EDIT: As far as your formulas go, the tax rate will be based upon your personal income, for any pass through entity. This means that the same monies earned from and LLC or an S-corp, with the same expenses and the same pass-through options will be taxed the same.

More reading: LLC and the law (Google Group)

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LLC is NOT a corporate entity, and is pass-through by default. It can opt-in to be treated as a corporation, and not necessarily S-Corp, it can be a C-Corp just as well. LLC and Corp are very different, and within the Corp class - S-Corp and C-Corp treatments are very different. While you've written many words, most of what you're saying is inaccurate, to say the least. –  littleadv Jul 10 '12 at 19:46
    
@littleadv - you might want to read the IRS rules (irs.gov/businesses/small/article/0,,id=98277,00.html) before you read Wikipedia and tell me I'm wrong. –  MaddHacker Jul 11 '12 at 1:09
    
It was you who quoted the Wikipedia, not me... The page you linked tells you exactly what I said: the default treatment for LLC is as disregarded entity. Please read your own text, and compare it to what you rely on, next time. What I said is right, what you said is... well, as I said, inaccurate, to say the least. –  littleadv Jul 11 '12 at 1:20
    
By the way, I see from your profile that you're in the UK.... The treatment of LLC's in the US is very different from the treatment of Limited Company in the UK. –  littleadv Jul 11 '12 at 1:21
    
@littleadv - a little adv(ice) for you, just because I'm in the UK, doesn't mean I'm not from the US, and have setup several LLCs (and C corps, and S corps) and have businesses in the UK as well. I specifically mentioned Wikipedia for a small piece, that I clearly quoted. You might want to look at the IRS website, talk to an accountant, talk to a lawyer and try it yourself. The rules are the rules, and every accountant and lawyer I've worked with is what you're getting a digest of. If you don't believe it, fine, talk to a lawyer/accountant yourself, which I always recommend. –  MaddHacker Jul 11 '12 at 2:02
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