How 3 different types of entities get taxed, by a Tampa Accountant!
The internet can be a rabbit hole of information, but what is the difference between an LLC, S-Corp, and C-Corp? A Tampa Accountant discusses!
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3 Common Types of Entities we'll review:
#1 - What a Single-Member LLC is and isn't.
A single-member LLC is one of the many entity types you will default to when initially creating your entity. The other defaults are a partnership (if you have 2 partners) and a corporation (this is the default for nonprofits as well).
When you go to apply for your EIN with the IRS and select "LLC" and input yourself as the sole member, you will default to the single-member LLC status. This means that you will not have to file a second tax return and all income/expenses for your LLC will be reported on your individual tax return Form 1040 come tax time. For IRS purposes, they see you and your business as one and the same since there's less legal separation and protections than that of S-Corporations or C-Corporations.
This entity type works best for side hustles, small businesses, and hobby income. By nature, those types of businesses don't bear much risk anyway and their taxable income is low enough to not warrant much savings from an entity conversion to an S-Corporation or a C-Corporation.
The difference between leaving your LLC as a sole proprietorship and converting to an S-Corporation can mean thousands and thousands of dollars in taxes. For simplicity, below are a few figures based on net earnings, and the taxes paid by both types of entities so you can see when it's optimal to convert.
Net Earnings of $25,000: LLC pays $4,300, S-Corp pays $900 ($4k difference)
Net Earnings of $50,000: LLC pays $10k, S-Corp pays $3k ($7k difference)
Net Earnings of $100,000: LLC pays $24k, S-Corp pays $11k ($13k difference)
As you can see, the more you make, the higher the difference in taxes paid vs taxes saved if you remain a sole proprietorship. This is because of 2 things: (1) The IRS incentivizes becoming an S-Corporation so that shareholders get on a reasonable/formal salary (think W2), (2) Second, sole-proprietorships were more designed for hobby income vs trades and businesses. Once you're netting over $25k, you start leaving money on the table by not converting!
Reach out to us to get a free consultation with a Tampa Accountant to address any accounting questions that you may have to make sure you're optimizing for tax time!
Read more about ABC's of LLC's here!
#2 - Why an S-Corporation may be the better choice for optimizing taxes.
As you can see from the table above comparing LLC vs S-Corp taxes, the needle really starts to turn around the $25k net earnings mark. By that point, you're leaving at minimum, $4k in taxes on the table. But what's more is, that you're missing out on other potential tax strategies such as starting your own retirement accounts (SEP IRAs, 401Ks, etc.)!
Retirement planning goes hand in hand with tax planning. With an S-Corporation, you have 3 years to start formal (W2) payroll. From there, your retirement options open up. 401k's and SEP IRA's are the most common retirement accounts for self-employed individuals and both are dependent on your W2 earnings. For example, with a SEP IRA, you can contribute up to $66k (2023) or 25% of W2 earnings. So if your W2 earnings are $100k, you can contribute $25k, with a $264k W2 topping out at the $66k cap. Every penny counts and at the end of the day, part of being self-employed is now relying on yourself as your retirement plan.
Reach out to us to get a free consultation with a Tampa Accountant to address any accounting questions that you may have to make sure you're not over-leveraging!
Looking to start a non-profit instead? Click here!
#3 - C-Corporations, the good and the bad!
A C-Corporation is a separate legal entity altogether. It has its own tax return and pays taxes at its own corporate rate (21% IRS + 5.75% FL). This entity type is also known as the 'double tax' entity because you get taxed at the corporate level and taxed again when you take dividends (distributions). While this might sound high, this entity type works out well for certain types of businesses such as:
Those with outside investors with convertible equity notes (S-Corps aren't usually accepted by investors because of the centralization of ownership)
Those with mostly foreign owners
Those whose owners are already in the top 39% individual tax bracket (corporate rate being 21% already gives you an 18% tax discount)
Those who use certain retirement accounts to fund the initial business purchase
A C-Corporation can be a very viable option (and a very optimized option) for the right type of business, but a big part of deciding on your entity type is tax planning! By tax planning, we can compare your net tax exposure between the entity types in the short term + long term to see what best benefits you and your long-term goals.
To learn more about payroll taxes, click here!
To learn more about sales tax, click here!
To learn more about other FL business taxes, click here!
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