Hoyt on Employment Tax Advantages of S Corps Over LLCs

Continuing his examination of the LLC v. S Corp choice of entity question, Christopher R. Hoyt (Missouri-Kansas City) weighs in on the employment tax considerations:

An important choice-of-business entity consideration concerns employment taxes. A sole proprietor of a service business will pay both the employer and employee share of OASDI and health insurance taxes (with minor adjustments) on all earned income. The same result occurs if the person forms a single-member LLC. If, however, that individual forms an S corporation and takes a small salary, some of the profits will be taxed to the shareholder without being subject to employment taxes. This was a political issue during the 2004 election when the newspapers reported that Senator Edwards, the Democratic Vice-Presidential candidate, saved thousands of dollars through his S corporation law practice [blogged here].

So how much money are we talking about?

Looking at S Corporations that were owned by one individual who pays himself / herself a salary, an average of 41.5% of profits was paid to the owner as salary in 2001. The remaining 58.5% of the income was taxed to the owner but avoided social security and employment taxes. The 41.5% figure is down from an average of 47% in 1994. See this Senate Report with several graphs, including this one:

With testimony like this in the Senate, it seems to me that it will only be a matter of time before we have legislation to put S corporations on par with LLCs when it comes to employment taxes. If that happens, then from a federal tax perspective it seems to me we should see more LLCs. Interesting, though, how some states have franchise taxes that discourage LLCs.

Update:  Joe Kristan offers detailed commentary here.