Since the introduction of S-Corp status, many businesses find themselves torn between which structure to choose. The whole debate around LLC vs. S-Corp in Texas can be confusing for new business owners, but we’re here to simplify it for you.
Imagine you’re going on a trip to Enchanted Rock in Texas. You have two routes to choose from. One route is scenic and shows you the charm of Texas, but it’s a longer drive. The other route is faster and saves fuel, but you’ll miss the beautiful views. Either way, you’ll reach Enchanted Rock. So, which route would you choose?
That’s similar to choosing between an LLC and S-Corp status. (Trust us… stay with us!)
In this article, we’ll first debunk the common misunderstanding between the two and give you a few quick pointers on each option.
Psst.. To help, you can skip ahead to use our free S-Corp vs. LLC tax calculator to see the tax differences based on your income.
Debunking LLCs vs S-Corps
First, let’s clear up a common misconception.
When choosing between an LLC and an S-Corp, it’s easy to get confused. An LLC, or Limited Liability Company, is a type of business entity, while an S-Corp is a tax designation.
When you start a business, you need to decide what type of entity you want to form(state level): sole proprietorship, partnership, corporation, or LLC. Note that your state does not give you the option to form your business as an s-corp. So where does the S-Corp come in?
The S-Corp question only arises when you’re dealing with the IRS (federal level) with respect to your tax filing status.
Here are the basics:
- First, you must be an LLC or a corporation to qualify for the S-Corp designation.
- You must file all requirements in Texas with the Texas Secretary of State.
- Unfortunately, partnerships and proprietorships aren’t allowed to have this designation.
- And finally, you need to select the S-Corp status using Form 2553.
Difference Between LLCs and S-Corps
Let’s return to our earlier analogy of a trip to Enchanted Rock. How does this connect to LLCs and S-Corps? Think of the longer, scenic drive as the LLC route and the faster, more efficient drive as the S-Corp route.
Let’s break down why.
LLCs: The Longer, More Flexible Route
Choosing the LLC route is like taking a scenic drive—it’s a bit slower and may cost more. As an LLC, you’re taxed like a sole proprietor or a partnership.
This means that the income your business earns passes through to you, the owner, and is reported on your personal tax return. As a result, you’ll pay self-employment taxes, which are 15.3% as of 2024.
In Texas, there’s no state income tax, which is a plus. However, you’ll need to consider the Texas franchise tax, which is 0.75% of the lesser of the following three:
• Total revenue minus cost of goods sold (COGS)
• Total revenue minus compensation
• 70% of total revenue
While the franchise tax is relatively low compared to a state income tax, it’s something to keep in mind when forming an LLC in Texas.
One advantage of LLCs is that they offer flexibility. Unlike corporations, LLCs don’t require a formal board of directors, regular board meetings, or strict management structures.
This relaxed structure is appealing to business owners who want fewer formalities but are okay with paying slightly higher taxes.
S-Corps: The Shorter, More Cost-Effective Route
Choosing the S-Corp route is like taking the shorter drive—it’s quicker and more cost-effective, but there are a few trade-offs. The main advantage of S-Corp status is the potential tax savings, particularly when it comes to self-employment taxes.
With an S-Corp, you only pay self-employment taxes on the salary you pay yourself, not on the entire income of the business. This can significantly reduce your tax liability.
But there are some limitations:
First, S-Corps only allow 100 shareholders, which is not ideal for companies planning to have more than that number. However, if you don’t anticipate expanding, being an S-Corp is better than the traditional C-Corp.
Second, S-Corps require a strict corporate structure. Here’s why the S-Corp route is the not-so-scenic route to take. A strict corporate structure can be tedious, given that you’d have to conduct regular meetings, establish board committees, and manage your affairs like a full-fledged corporation. Unlike in an LLC, where the management structure can be a bit relaxed.
Lastly, profit sharing in S-Corps is prorated to your ownership percentage. If you own 10% of the company, you get 10% of the profits. Meanwhile, in a C-Corp, profit sharing can be flexible. A shareholder can receive more profit share even if they only have a small ownership percentage.
If you’re unsure whether the S-Corp designation would save you more in taxes, use our free tax calculator to see a personalized estimate.
Which Should You Choose for Your Texas-Based Business?
Deciding between an LLC and an S-Corp comes down to your specific business goals and financial situation.
While many business owners lean toward the S-Corp for potential tax savings, it’s important to evaluate whether the additional administrative work is worth it for your practice.
Choose an LLC if:
- You want flexibility in how you manage your business and prefer fewer formalities.
- You’re okay with slightly higher taxes in exchange for simpler tax compliance.
- You want the flexibility to share profits in any way, regardless of ownership percentages.
Choose an S-Corp if:
- You’re looking for tax savings and plan to pay yourself a salary as an owner-manager.
- You don’t mind handling the added formalities and administrative tasks required for S-Corp compliance, such as holding regular board meetings and maintaining a strict corporate structure.
However, we typically only recommend electing S-Corp status if your business is generating at least $80,000 to $100,000 in revenue.
This is because the additional costs—such as payroll compliance associated with your salary and the time spent on administrative tasks—may outweigh the tax savings if your revenue is lower than that threshold.
To see how much tax you could save, try our S-Corp vs. LLC tax calculator.
Need More Help Deciding Between LLC vs. S-Corp in Texas?
If you’re still unsure which structure is right for your business, our team is here to help.
Here at Traktion, we specialize in helping Texas-based businesses make smart financial decisions. From choosing the best business structure to managing your cash flow, we’re here to be your financial coach every step of the way.
To find out the best options for your business, simply head over to our Contact page to fill in a few details and schedule your first introductory call.
In the meantime, don’t forget to try out our free S-Corp vs. LLC tax calculator to see how much you could save.
Until next time!