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Corporation vs. LLC – Tax Benefits of Each

Determining the best entity for your business is a complex but important decision that you will make.

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Corporations and LLC’s offer liability protection. Without Liability Protection, anytime you interact with another person, there is a risk. From a liability standpoint, think of an LLC or Corporation as insurance for your personal assets. By operating as a Sole Proprietor or Partnership, you are personally liable for all business debts. You are also potentially liable for any lawsuits that may arise. Sole Proprietors and Partnerships also must pay self-employment tax on the net income of the business.

LLC’s are the simplest to form.  They do not have formalities and record keeping requirements that Corporations have.  For tax purposes, the financial data passes through to your personal return.  You generally owe self-employment on your net income up to $106,800 for 2010.  However, you can elect to be taxed as an S-Corporation.

S-Corporations offer the opportunity to save on self-employment taxes after paying a reasonable salary.  Like a C Corp, Payroll taxes must be paid for salaries and wages.  However, there is no payroll tax on the extra income your company makes. 

As a business owner, you cannot abuse this benefit.  You cannot take an artificially low salary with the sole intent of avoiding payroll taxes – hence the term reasonable salary. 

The main drawback for an S Corporation is the lack of easy operation. There are differences in formalities and record keeping requirements.  For example, you must have shareholders and stock  – as well as a board of directors and officers.

C-Corporations are similar in structure to an S-Corporation.  The tax on salaries and wages is essentially the same.  This entity type can save money for high income earners.  For example, if you (personally) are in the highest income tax bracket, you can leave a portion of your profit inside the C-Corporation.  This saves tax dollars because the first $50,000 in corporate profits is taxed at the 15% rate.  By splitting the income, you may be able to stay out of the top tax brackets.

The main drawbacks with a C-Corporation are the same as those of an S-Corporation.  They lack ease of use, they have a more complex structure and are more formal, they require more maintenance, and they both require having to file another tax return.

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