There is a lot of tax similarity between LLC’s and S-Corporations.
Both LLC’s and S-Corporations are pass-through entities. For example, to avoid paying both personal and corporate taxes, corporate taxes are paid by the business, not the owner. The business is also responsible for all debts and liabilities. In addition, both LLC’s and S-Corporations have tax deductions such as travel, pre-tax expenses, and health care premiums.
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In contrast, there are many differences between LLC and S-Corporation. LLC’s can have an unlimited number or members. S-Corporations are limited to 100 shareholders, cannot be owned by another corporation or entity, and they cannot issue stock with preferable distributions. Unlike LLC’s, S-Corporations can transfer ownership easily as long as IRS requirements are met.
As a tax benefit, S-Corporations can add the owner of the corporation an employee and pay employment taxes. The income of an LLC member is subject to the higher rate self-employment tax contributions. S-Corporation shareholders receive their profits and losses based on their percentage of ownership while LLC’s can allocate profits and losses on any basis they want. Because of its flexibility, it is fairly easy to setup an LLC’s. However, S-Corporations have strict tax code setup guidelines while LLC’s are fairly easy to setup with no strict tax code guidelines.
Based on this knowledge, I would recommend to Bob that the most advantageous formation for his consulting business would be an S-Corporation. Even though an LLC is easier to setup than an S-Corporation, an S-Corporation has more tax deductions than an LLC. If Bob would want to sell the business, or transfer the business to a family member, such as son or daughter, this can be easily done. In addition, there would not be any single member LLC self-employment tax on income generated in the LLC, which would mean paying higher taxes at the estimated tax rate.
Bob can take advantage of the payroll tax deduction.