Hi. I’m Tim Mayclin, CPA from Rohnert Park, California. Today we’re going to talk about incorporating, what the difference is between a sole proprietorship or an LLC versus an S-corporation. I get the question a lot of whether the company should be an LLC or whether it should be an S-corp. There are two parts of the equation, one is legal, one is tax. The legal perspective, talk to an attorney. On the tax side, there can be a significant difference between an LLC or sole proprietorship and an S-corporation. Here are some numbers that we’ll go through the process.
On the sole proprietorship, let’s say the income is $100,000, that’s the profit from the business. The tax difference on an LLC or a sole proprietorship and an S-corp is all in the self-employment tax. On a business that generates $100,000 of net profit they’re going to pay $15,300 of self-employment tax. That goes to the government. In addition, they pay income taxes, which is the same whether it’s a sole proprietorship or an S-corp. Under an S-corporation though, the payroll taxes are not paid on the $100,000, they’re only paid on the salary as long as it is reasonable.
If a reasonable salary for this business would be $50,000 for example, that’s the number that the payroll taxes is paid on which ends up being about $7,500. So, instead of paying the government $15,300 you’re paying roughly $7,500 in payroll taxes. That’s a significant difference. There are some downsides such as retirement plans are based on this number for the sole proprietorship, the 100,000 versus they’re based on the 50,000 on S-corporations. If you’re thinking about incorporating for your business, please contact your local CPA.
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