Starting a small business is exciting, but it can also feel overwhelming once you realize how many new decisions are on your plate. One of the first questions many new owners face is: “Should I set up my business as an LLC or an S Corp?”
This is where people sometimes get tripped up. An LLC and an S Corp are not two versions of the same thing. An LLC is a legal way to set up your business, while an S Corp is a tax choice you can make later. They do different jobs, and sometimes, the smartest move is using both together.
What’s an LLC?
An LLC (Limited Liability Company) is a way to legally register your business with your state. The main benefit is personal protection, so if your business gets sued, your personal assets like your home or savings are usually shielded.
You can form:
- A single-member LLC if you’re the only owner.
- A multi-member LLC if you have partners.
How taxes work for LLCs by default:
- If it’s just you, the IRS sees your LLC as a sole proprietorship. Your business income goes directly on your personal tax return.
- If you have partners, the IRS sees it as a partnership. Each partner reports their share of profits on their personal tax returns.
This is called pass-through taxation because the business itself doesn’t pay taxes; the profits “pass through” to you. The downside is that all those profits are also subject to self-employment taxes (Social Security and Medicare).
So, that’s the basics of an LLC. But what about an S Corp? This is where things often get confusing, because it’s not a separate type of business, it’s a tax choice.
What’s an S Corp?
As we mentioned above, an S Corporation (S Corp) isn’t the type of business you form with your state. It’s a tax classification you can elect with the IRS, usually after you’ve already set up an LLC or a corporation.
The main reason business owners elect S Corp status is for potential tax savings.
Here’s how it works:
- You pay yourself a salary, just like an employee. That part is taxed normally.
- Any additional profits can be taken as distributions, which is basically a payout of the remaining profits, and they aren’t subject to self-employment taxes.
This split can lower your overall tax bill, but it comes with responsibilities: you must pay yourself a “reasonable” salary, run payroll properly, and keep up with some additional filing requirements.
Payroll Rules to Know
This is another area where many new business owners may get confused.
- Single-member LLC (not taxed as an S Corp): You cannot pay yourself a W-2 paycheck. You take money out as an owner’s draw. For example, whether it’s “Joe Smith” operating as a sole proprietor or “Joe Smith LLC,” if he isn’t an S Corp, he cannot be paid as a W-2 employee.
- S Corp: You must pay yourself a W-2 wage before taking any distributions from profits.
- S Corp with 2%+ owners: If an owner has at least 2% of the company and is on payroll, their benefits (like health insurance) are taxed differently than those of regular employees.
Because of these differences, payroll providers need to know right from the start whether a company is an S Corp so they can set up pay and benefits correctly.
How LLCs and S Corps Fit Together
Remember, you’re not choosing between “LLC versus S Corp” as two separate lanes. Instead, your options are:
- Be an LLC without S Corp status (the default for most new LLCs).
- Be an LLC that chooses to be taxed as an S Corp.
- Be a corporation that chooses S Corp tax status.
Which Should You Choose?
At the end of the day, choosing between an LLC or an S Corp is both a business and a tax decision.
- LLCs provide personal asset protection and are simple to set up.
- S Corps may help you save money on taxes once your business is profitable, but they require more recordkeeping and payroll compliance.
- Many business owners start with an LLC and later elect S Corp status as their business grows.
There are pros and cons to both, so it’s always best to consult with a qualified tax professional before deciding which structure is right for you.
Bringing It All Together with Commonwealth Payroll & HR
Choosing between an LLC and an S Corp is just one of the many decisions you’ll face as a new business owner. But once you’re set up, you don’t have to figure out payroll and compliance on your own.
At Commonwealth Payroll & HR, we work with small businesses every day that are in this exact stage. We’re making sure payroll is set up the right way for their business structure, and that pay, benefits, and taxes are handled correctly from the start. Think of it as turning over the tricky stuff to people who do it all the time, so you can keep your energy on running and growing your business. Ready to take payroll off your plate? Let’s talk about how we can set up your new business for success.
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