Taxes of an LLC

The other day, one of my sons was walking around the house in my shoes. When I noticed this, I playfully began chasing him around. He noticeably stumbled and was slowed down because the shoes didn’t fit him. Once he kicked my shoes off, he was instantly much more efficient in running away from me.

Using that above story as an analogy -- I meet with a lot of business owners that want to be taxed as an S-Corp without knowing much about what that means. Oftentimes, they get advice from their neighbor or a friend with good intentions but not necessarily all the information. The point I try to emphasize with them is that there is no “one-size-fits-all” way to setup a business. Let me illustrate with an example:

Facts for this example:

• Danae has set up an LLC for her new business and she is the only owner.

• Her business’s projected taxable income before officer compensation is $100,000.

• A reasonable compensation for her industry is $40,000.

• Her filing status is single.

In this situation the most common options for her would be to be taxed as a Sole-Proprietor (Form 1040 Schedule C) or to be taxed as an S-Corp (Form 1120S). Comparing those two taxation models, she would save over $5,000 tax dollars by being taxed as an S-Corp. However, she would have additional accounting fees to file an S-Corp tax return, to run payroll, and to file quarterly and annual payroll tax reports. Even with those accounting fees factored in -- she would come out ahead by filing as an S-Corp.

However, what if we change the facts so that her business’s projected taxable income before officer compensation is $50,000. Keeping everything else the same, she would pay about the same amount in taxes either way. However, if she was taxed as a Sole Proprietorship she would avoid the additional accounting fees as she wouldn’t have to file a separate business tax return or file any payroll reports. Accounting fees can add up quickly, so in this scenario she would be better off to be taxed as a Sole-Proprietorship.

So, as you can see -- there is no “one-size-fits-all” setup for a business. The advice to setup your business with an S-Corp tax election may be good advice, but it might also be bad advice. My goal with my client’s is to help them operate at a level where they can run efficiently.

If you are looking at starting a business and what to talk about your options for entity structure, or if you own a business and want to see if you are operating under the correct structure I would love to meet with you and discuss your business.