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When establishing a small business, choosing the right structure is crucial. One common strategy is forming a Limited Liability Company (LLC) for its legal advantages and electing to have it taxed as an S Corporation (S Corp). This choice can offer significant tax benefits while maintaining the flexible legal structure of an LLC.
Benefits of an S Corporation Tax Election
Opting for an S Corp tax status can be particularly advantageous for small business owners. An S Corp allows you to receive both a salary and distributions from the company. The IRS requires that you take a reasonable wage, but the ability to also take distributions means you can save on some payroll taxes. This blend of salary and distributions can result in substantial tax savings.
Why Choose an LLC?
Many lawyers recommend setting up a company as an LLC due to its flexibility. An LLC can be taxed in several ways: as a default entity (usually a partnership or single member LLC), an S Corp, or a C Corporation (C Corp). This versatility allows business owners to select the most beneficial tax structure for their specific situation without changing the legal nature of the entity.
Choosing the Right Tax Structure
The decision between an S Corp, partnership, or C Corp typically hinges on tax considerations. Here are the key differences:
- S Corporation: Most advantageous for small businesses aiming to save on taxes. However, S Corps are limited to one class of stock, meaning all shareholders are treated equally.
- Partnership: Allows for different classes of interest, offering flexibility in ownership and profit distribution, but may result in higher taxes compared to an S Corp.
- C Corporation: Ideal for businesses seeking outside funding. A C Corp can have multiple classes of stock and offers benefits like qualified small business stock, which can lead to significant tax breaks when selling the company. However, C Corps are subject to corporate taxes (21% federally, 8.84% in California).
Consulting with an Accountant
Given the complexities and potential tax implications, consulting with an accountant is essential. They can provide tailored advice to ensure you choose the best structure for your business’s unique needs. While an S Corp is often the go-to choice for small businesses, it may not always be the optimal solution. An accountant can help you navigate these decisions and make the most informed choice.
In conclusion, while an S Corp election can offer substantial tax benefits, the best choice depends on your specific business goals and financial situation. Whether you opt for an LLC, S Corp, or C Corp, professional guidance is crucial to making the best decision for your business.
Contact our team to help you make the right decision for your business.