In this video, Matt Blocki from EWA outlines the key differences between an LLC partnership and an S Corporation, focusing on two main factors: taxes and flexibility. He explains that tax implications vary between the two structures, with an S Corporation offering potential tax savings, especially for Medicare and Social Security taxes. However, S Corporations require careful consideration of audit risks and the impact on retirement plan contributions. On the other hand, an LLC partnership provides greater flexibility in distributing profits, allowing partners to tailor income allocations based on various factors, including workload and ownership percentages. Ultimately, the choice between these structures should consider both tax implications and the desired level of flexibility, as well as the number of members involved in the business.
Matt with EWA. Today we are talking about the differences between an LLC partnership and a S corporation. So if you are a new aspiring business owner or an existing business owner, today we’re going to break down really the two key difference and factors in the decision process whether to maintain your current setup or change your setup.
So the main differences between an LLC partnership and an S Corp come down to two factors. And these aren’t the only factors. But myself being a business owner, these are the two biggest factors in my mind of why one would choose one over the other.
So the first factor is just simply taxes, and the second factor is flexibility. So from a tax standpoint and the assumption here is that you are a partner with active income from either or if you’re a passive investor in LLC partnership, some of the things I’m going to share with you today would not apply.
So we are assuming that you’re an active team member, active owner of a business. So in the LLC partnership, there is a tax disadvantage because you get a guaranteed payment. And then if the business is profitable, you’ll have a profit.
And both of those guaranteed payments and the profits are going to get hit. For federal, state, Medicare and Social Security, tax it. As an S Corp, you’re still going to have federal, you’re still going to have state.
However, the Medicare and Social Security depends on whether you’re a W two or whether you’re taking a dividend out of the company. So a w two still gets hit for medicare and still gets hit for Social Security.
The dividends get hit with federal and state, but the medicare and the Social Security you avoid on the dividends. So just hypothetically, if you had a $300,000 total income so let’s just break this down.
Between 100,000 of a guaranteed payment and 200,000 of a profit, all $300,000 would get hit with the federal, state medicare. And obviously Social Security is capped at about half of that. But if the w two and dividend the 100,000 of w two and 200,000 of dividend, that 200,000 getting distributed out of the 300 would avoid medicare tax.
And between 100 to about 148,000 on the Social Security, there’d be significant savings there for a S corporation election. Now, one thing you do have to be careful about, if you’re making that much money and pay yourself a w two that low, there is an audit risk.
So for example, if you’re a doctor that owns a private practice and you’re specialized and the average compensation for your specialty is 300,000, most likely that should be a w two. If you get audited, the government’s not going to like that.
You’re avoiding all those taxes. So there’s tax savings techniques to an S corporation, but there are also audit risk there as well. So one other disadvantage of paying that high of a dividend is the w two is what your 401 and pension contributions are based upon.
So if you only paid yourself 100,000 out of the 300,000 as w two, you would not be able to reach the four one five C limit of 61,000. In your 401K. For example, if you wanted to put 20,500 into your elective deferral and then 40,500 into profit sharing, that profit sharing is 25% of only your w two.
That will be 25,000 instead of 40,500. So you wouldn’t be able to reach the cap, which would then you lose taxes because that would be a tax deduction for you. So there’s clearly an artwork and a balancing between factoring in the taxes and then also balancing are you going to do a retirement plan in place?
But in general an S corporation is more favorable from a tax perspective. Now, where an LLC partnership is more favorable is for flexibility purposes. So for example, if you’re a partnership or have two equity holders in your business, we’ll use the example of 51% for person one and 49%.
We’ll call that person A and 49% for person B. Whatever the profits are for the S Corporation, it is rigid. Those profits have to be distributed 51% to the equity holder that owns 51 and 49% to the equity holder that owns 49% to a partnership.
It is flexible. You can distribute the money separate from the actual percentage of ownership. So if the person owning 49% did more work and the partners agreed, or if the 51% owner had the majority rights to decide how the compensation that person could say person B, I was on vacation all year.
You’re going to take 80% of the profits. I’m only going to take 20%. So there’s tremendous flexibility in an LLC partnership versus in an S corporation, at least from a profitability standpoint, it is very rigid.
And to get around that, you’d have to do w two bonuses. But then the taxes that you were trying to save by being an S corp would get erased because the bonus which would then lower the profit, would have to hit all those.
Different tax factors, and what you’re trying to achieve up here got erased by. Achieving the flexibility. So if you have any questions on which one’s best for you, these are the two factors that we would look at closely taxes and flexibility.
And then specifically, how many members. Do. You anticipate having in your company. In the future? Is it one. Manager, two manager? Who’s the decision makers? There’s a lot of factors, but these are the main two from a tax and flex stability.
Standpoint that we would recommend to consider when making the decision. To keep your current status or whether. To switch the status between these two.