LLC vs. corporation
Wednesday, February 1st, 2012
We received this question from a budding entrepreneur about setting up as an LLC or a corporation:
- I am looking to set up a small business. I am debating on whether an LLC or S-Corp would be better. I am looking to decrease taxes and limit my liability. I, as the owner, will work in the business and will have a very small salary.
Thank you for contacting us with your business question. First of all, we are not attorneys, so we cannot offer you legal advice, and there are legal details to consider. Big-picture though – an LLC or corporation provides a greater degree of protection against personal loss if something bad should happen that affects your company. Taxation is a factor to consider, but it is one of many.
From a federal tax standpoint, if you are the only member (i.e., owner) of the LLC, you use the same tax form as if you were a sole proprietor – Schedule C of your personal tax return. If you have a partner, you report on a partnership return (1065) and report your share of the profits on your personal return. Either way, you pay taxes on the net income, regardless of the amount of money you take out of the company. The taxes consist of self-employment tax (Social Security and Medicare) and income tax.
Owners/partners cannot take a salary; they may take a draw against the company’s profits but that does not affect the net income they pay taxes on. In other words, the LLC does not get a deduction for money its owners take out. A corporation does get a deduction, because it pays everyone (including the owner who works in the business) as employees. An S-corporation’s net income flows through to the owners as a partnership’s does.
In Tennessee, an LLC or corporation must pay a franchise tax based on the value of its assets or net worth, and an excise tax based on its net income. One big difference – for the LLC, you back out the net income that you pay self-employment tax on. This effectively reduces the excise tax to zero for an LLC, whereas a corporation (including an S corporation) does not get this break. This often sways the decision toward the LLC, although you must “run the numbers” to determine which strategy results in the lowest tax at both the company and personal level.
There are many factors and decisions to be made when starting your business. I recommend that you contact the Tennessee Small Business Development Center. These good folks are dedicated to helping entrepreneurs cover all the bases and get started on the right foot with their new ventures. You can reach them at www.tsbdc.org and (865) 246-2663.
We’re seeing quite a few new business owners, and we welcome you. After all, every business starts out small. Where it goes from there depends on many different factors, including good financial decisions.