Choosing Between an LLC and S-Corp
"A well-researched summary"
First, the the obvious: I'm not a CPA or tax expert. That being said, I can read and take notes, and I've spent longer than I care to admit researching the topic of Which Business Legal Structure Is Best For My Exterior Cleaning Business? Since 2012, my little business of Outside Cleaners has been set up as an LLC ("limited liability company"), but my tax guy has suggested (again) that I should consider switching to an S-Corp. Here's a summary of what I've learned:
For us Massachusetts small business owners, the choice between operating as an LLC (Limited Liability Company) or electing S-Corp (S Corporation) status can impact everything from taxes to health insurance costs. Most "tax pros" seem to consider our income's impact on our taxes, but not the significant impact of our health insurance costs. In my strong opinion, that is a mistake.
LLC: Flexibility and Simplicity
An LLC is a flexible business structure that protects personal assets while requiring minimal formalities. It’s a popular choice for small businesses, especially those just starting out. The benefits of this business structure are:
- Simple Administration. LLCs require fewer annual reports and meetings than corporations, reducing the time and cost of compliance.
- Taxation Flexibility. By default, an LLC is a “pass-through” entity, meaning profits are taxed on your personal return. However, you can elect to have your LLC taxed as an S-Corp or C-Corp.
- Profit Distribution Flexibility. LLC owners can allocate profits in ways that don’t necessarily match ownership percentages, as long as it’s documented in the operating agreement.
- Lower Costs for Small Businesses. Maintaining an LLC in Massachusetts can be more affordable than an S-Corp, particularly for businesses with modest earnings.
... but the drawbacks of an LLC are:
- Self-Employment Taxes. LLC owners pay self-employment taxes (15.3% as of 2024) on all profits. This can result in higher tax bills for businesses earning significant income.
- Limited Tax Optimization. LLCs don’t allow you to split income into salary and distributions like an S-Corp, which limits your ability to lower payroll tax liability.
- Less Scalability. LLCs may be less attractive to investors or partners due to their flexible but informal structure.
S-Corp: Tax Savings with Structure
Technically, an S-Corp is a tax status, not a type of entity. Both LLCs and corporations can elect S-Corp taxation, provided they meet certain IRS requirements. It’s particularly advantageous for businesses with steady or growing income. The benefits of an S-Corp are:
- Reduced Self-Employment Taxes. S-Corp owners pay payroll taxes only on their “reasonable salary.” Profits taken as dividends are not subject to self-employment taxes, offering substantial tax savings.
- Formal Structure for Growth. The formal structure of an S-Corp can be beneficial for businesses looking to hire employees or scale.
- Potential Tax Savings. For businesses earning $75,000 or more annually, the tax savings from lower payroll taxes often (but not always) outweigh the additional costs of running an S-Corp.
...and the drawbacks of an S-Corp are:
- Administrative Complexity. S-Corps require payroll, detailed bookkeeping, and additional filings. Professional services to manage compliance can cost $2,000–$3,000 annually.
- Reasonable Salary Requirement. The IRS mandates that S-Corp owners take a reasonable salary before distributing profits. Determining and justifying this salary can be tricky.
- Ownership Restrictions. S-Corps can have no more than 100 shareholders, and they can only issue one class of stock, which may limit growth opportunities.
- Profit Distribution Rules. Unlike LLCs, S-Corps must distribute profits strictly according to ownership percentages.
The Crucial Role of MAGI and Health Insurance
For Massachusetts business owners, the relationship between your business structure, your Modified Adjusted Gross Income (MAGI), and health insurance costs is crucial. MAGI determines eligibility for health insurance subsidies through the Massachusetts Health Connector, so understanding how each structure impacts it can save you thousands in health insurance costs annually.
LLC Impact on MAGI: As an LLC owner, all net business profits count as personal income, increasing MAGI. A higher MAGI may disqualify you from healthcare subsidies, leading to higher insurance premiums. But, crucially, the LLC structure allows many ways to reduce your MAGI, even after the current tax year (such as SEP IRA contributions).
S-Corp Impact on MAGI: S-Corps offer some flexibility in managing your overall tax burden, but it’s important to understand that both the salary and distributions you take as an S-Corp owner are considered taxable income and contribute to your MAGI.
As an S-Corp owner, the IRS requires you to take a “reasonable salary” for the work you perform. This salary is subject to payroll taxes and is included in your MAGI. Profits distributed to you as the owner are not subject to self-employment taxes, but they are still taxable income and therefore contribute to MAGI.
Bottom Line: Rules-of-thumb are fine when discussing general best practices for big groups or populations, but they don't apply to every single case. As far as I can tell, the only way to figure out which legal structure is right for YOUR business is to go through the math in both scenarios. Then, look ahead and guess how your income and situation might change.
I guess my situation is an odd duck, because as it turns out, the details of my little business are such that I'm best remaining structured as an LLC. The reason: tax savings of an S-Corp are less than the combined costs of S-Corp paperwork and the higher health insurance costs I'll incur under that entity. This is true primarily because of the money I keep shoveling into my SEP IRA and the money I keep re-investing into my business.
References for Your Research
Massachusetts Health Connector Income Guidelines
Reasonable Salary for S-Corp Owners





