I often come across some version of this question on social media. It goes something like this:
“I am going to be doing some moonlighting. Should I open an LLC or an S corp? Which one protects me more from malpractice?”
Or,
“I’m opening my own private practice. Is there a certain income threshold before I set up an S corp. How do I maximize retirement savings and save on taxes?”
First things first, the two are not interchangeable. They do not even pertain to similar things.
An LLC is an entity filed with your state to limit your liability. An S corp is an election of tax status.
Limited Liability Corporation (LLC)
An LLC is an entity you file with your state. One you create to limit your liability, related to the business, to the assets held by the corporation, thereby protecting your personal assets.
Now, physicians should remember that this does not cover medical liability. Medical liability is considered personal and therefore you are not protected by holding your practice within an LLC. Only malpractice insurance protects you in this situation. And in the rare event of a verdict above your malpractice insurance, your personal assets are on the line- unless you have other asset protection in place, as you should. For example, retirement accounts are protected and so is your primary residence in many states.
That said, there are other areas of liability you are protected against with an LLC. For example, if you have a medical office and someone slips and falls on your property and sues you for it, an LLC structure would help. Or if one of your employees files suit against you, your personal assets are not in question.
Setting Up an LLC
Setting up an LLC is fairly simple. You look up the Division of Corporations for your state, follow the instructions to file the Articles of Organization and pay a fee. For example, in Florida, the Division of Corporations is called Sunbiz.org. On their website, they have forms you can fill online, with instructions. You pay the filing fee of $125 and done.
The Articles of Organization Form itself is mostly demographic information of the business and its representative- also called the Registered Agent. Since I am a single-member LLC, I am also the Registered Agent. You may choose your attorney or accountant to be the Registered Agent if you choose.
LLC and Taxes
An LLC is not a separate tax entity as per the IRS. It is a “pass through” entity. Which means that the tax liability passes through to the LLC owners to be reported and filed in their individual tax returns. An LLC does not have to pay extra taxes or file a separate return with the IRS.
A single member LLC is called a Disregarded Entity. So, similar to a Sole Proprietorship, you and your LLC are treated as one and the same.
You report your profits/losses from the LLC on Schedule C (Profit or Loss from Business) of your tax return. This then goes on line 3 of Schedule 1, which in turn feeds into line 7a of Form 1040.
A multi-member LLC is taxed as a Partnership. Similar to a single-member LLC, the tax liability passes through to each member and they pay taxes on their portion of the business profit on their personal taxes.
So, essentially, an LLC does not save you anything on taxes.
S corp
An S corp, on the other hand, is a tax filing status.
A business has to make an election with the IRS to be taxed as a corporation. A S corp is also a “pass through” entity- in that the tax liability passes through to its owners.
But there is a small difference. With an S corp, you are both an owner as well as employee of your business. This lets you take some compensation as an employee (that is, W2) and the rest as S corp profit or distributions.
On the amount designated as S corp distributions, you do not have to pay Self Employment taxes. So, you get to save some money on taxes.
How much? This is where it’s a little grey.
S corp and Taxes
So you get to save Self Employment taxes on the portion of business income designated as distributions. So why not call all or most of your income as distributions? Because the IRS frowns upon it.
The IRS wants you to take a salary, ie the W2 portion, that is “reasonable” for your work. So, you need to pay yourself via W2 an amount commensurate with what is average or expected for your specialty, in your area. This is where it is not well-defined. I think a reasonable range, that you can defend to the IRS, will work. So, as a cardiologist, if you make $500k- whether you take a W2 of $250k or $300k doesn’t matter much; but $100k in W2 and $400k as distributions, will probably not fly with the IRS.
Tax savings with S corp
So how much is your expected tax savings with an S corp election? Assuming that you pay yourself enough in salary to max out Social Security tax, the only tax saving is in Medicare tax: 2.9% unto $200k, as a single filer or $250k as married filing jointly. Above that, it is a 3.8% savings, since 0.9% Medicare surcharge (or Obamacare tax) is added to the usual 2.9%.
Say you are a high earner, who takes $250k in salary and file your taxes as married filing jointly, you save $3800 for every $100k in distributions.
This is partially offset by the increased expense of setting up and maintaining an S corp.
I hope this is helpful in figuring out your own situation. None of this is professional advice- so please consult one of the good folks who do this for a living. Find a recommended advisor from the Recommended Resources here and support those who help support this site. Thank you!
