LLC versus S-corp: How to pay yourself
Know your options when it comes to incorporating and making things official.
Business and financial manager Belva Anakawenze has got you covered. She'll explain the most common business structures for creators and give you the low down on how different business structures might impact your legal liability, tax situation, and even your operating decisions.
This video is intended as knowledge-sharing, not tax, financial, or legal advice. Always consult with tax/financial/legal professionals to determine what's best for your business.
If you're an independent creator, you've no doubt heard about business structure. Maybe you've heard terms like sole proprietor, LLC, S-corp. I know this can seem overwhelming but I'm going to lay out the key tax differences between each so you can make an informed decision about which one is right for you.
I'm Belva Anakwenze and I work with creators every day helping them with financial and business decisions just like this one but before I dive in, keep in mind this video is for informational purposes. Business formation rules are complex and they vary state by state. Always consult a professional to figure out what's right for you.
In the US, there are several business structures. I'm going to give you an overview of the four most commonly used for creators, sole proprietorships, LLCs, S-corps, and C-corps. This should give you a better idea of which one might be right for you.
Sole proprietorships, LLCs, S-corps, and C-corps have several operational differences. I'll be covering one of the main differences which is how they're taxed and there are two different types of taxes to consider, income taxes and payroll taxes.
Let's start with the entity structure that will probably be most familiar, sole proprietorship. A sole proprietor is what most gig workers and creators are in the beginning of their career. It's essentially a way of operating a business as yourself. You might operate under a pseudonym and possibly even have a unique federal identification number that is completely different than your own personal Social Security number but essentially, it's just you operating.
There is absolutely no tax difference than if you are being taxed as an independent contractor. You're taxed on your earnings when you file your individual tax return. If you have a nine-to-five job and you look at your pay stub, in addition to your federal and state income taxes, you'll see taxes withheld for Social Security and Medicare. Those deductions equate to about seven and a half percent of your paycheck. Your employer is matching that same seven and a half percent for a total of 15%.
When you operate as a sole proprietor, you take on the role of the employer and the employee for a total of 15% which is taxed on your business profit and that is on top of your normal income tax rate.
On the other end of the spectrum, you have a corporation. Not many creators end up forming corporations but for the sake of explanation, in a corporation, you are a shareholder in that business. This is the same structure large public companies use. There could be one shareholder or an unlimited amount of shareholders. The business operations are run by its board of directors and its shareholders.
There are a lot of requirements and paperwork needed to set up a corporation especially compared to a sole proprietorship but once that's all sorted out, the business would be a separate entity with its own separate assets and income. Now, that means the corporation pays tax at the corporate tax rate completely separate from you as an individual. The corporation then pays you in the form of dividends or wages and then you personally pay tax on that income.
That is where the term double taxation comes into play. The corporation is taxed and the money the corporation pays you is taxed again on your personal return. And if you take wages from the business, the corporation is the employer. So like we talked about earlier, the corporation is gonna pay seven and a half percent in payroll tax and you as the individual will pay seven and a half percent as well.
“Keep in mind these four are not your only options and there are even more differences between these structures…But remember this: If you're bringing in money for your work…you're technically a sole proprietor already.”
The other two structures, S-corps and LLCs fall somewhere in between sole proprietorships and corporations. Just like with the corporation, an S-corp also known as a small business corporation requires a lot of paperwork to register and to get it set up but it's essentially a regular corporation electing to be treated like a small business.
When you look at how an S-corp is taxed, that's where things get different. An S-corp is considered a pass-through entity. This means from a federal perspective, the S-corp is not taxed. Instead, the losses or profits pass on to you as an individual and then you personally pay taxes on those profits on your individual tax return.
Here's one of the benefits of an S-corp though. When it comes to those payroll taxes, you get to avoid the 15% in Social Security and Medicare. The profit from the S-corp still passes on to you as an individual but you are only paying tax at your normal income tax rate. Now, this can get a little nuanced with a need to put yourself on payroll and possibly more, so this is just generally speaking.
The last structure on our list is the limited liability company or commonly known as an LLC. Now, in some ways, an LLC sits right in the middle of our other options.
To set up an LLC, you'll have to file some paperwork but probably not as much as a corporation. Now, when it comes to taxation, LLCs leave you with options. Generally speaking, you'll be taxed exactly like a sole proprietor but qualifying LLCs can elect to be taxed like a pass-through entity like an S-corp, and in some cases, they can choose to be taxed separately like a corporation.
Again, keep in mind these four are not your only options and there are even more differences between these structures. You can dig into these differences with the resources linked below but if you're considering whether or not you need a formal business structure, remember this: If you're bringing in money for your work even if you're not turning a profit yet, you're technically a sole proprietor already.
While you may not need to do anything further, it's good to know what other business structures are available to you. Hopefully, this helps you make an informed decision. Make sure you like this video and subscribe to this channel for more helpful financial tips and tricks and let me know down in the comments what other questions you have around business operations and finances. Until next time, go be creative with your business.