One factor that differentiates an S corporation from an LLC is the employment tax that is paid on earnings. The owners of an LLC are considered to be self-employed and, as such, must pay a self-employment tax of 15.3% which goes toward social security and Medicare. The entire net income of the business is subject to self-employment tax.

In an S corporation, only the salaries paid to the employee-owners are subject to employment tax. The remaining income, paid as distributions, is not subject to employment tax under IRS rules. Therefore, there is the potential to realize substantial employment tax savings. Case in point:

Mary owns a print shop. In keeping with the industry standard, Mary decides that a reasonable salary for a print shop manager is $35,000 and pays herself accordingly. Mary’s total earnings for the year are $60,000: $35,000 paid in salary and the remaining $25,000 paid as a distribution from the S corp. Mary’s total employment tax is $5,355 (15.3% of $35,000).

If Mary were the owner of an LLC, she would have to pay employment tax on the entire $60,000, equaling $9,180. But as an S corporation, she realizes savings of $3,825 in employment tax.

One might assume that these savings could be further manipulated by reducing the salary to an extremely low amount and attributing the rest of one’s earnings to distributions—but this would be an incorrect assumption. In practice, the IRS is careful to notice whether a salary is reasonable by industry standards. If it determines a salary to be unreasonable, the IRS will not hesitate to reclassify distributions as salary.

Still, while the potential employment tax savings may make the S corporation an attractive structure for your business, bear in mind that you would then have to deal with the administrative burden associated with payroll tax. The payroll tax is a pay-as-you-go tax that must be paid to the IRS regularly throughout the year, or you will incur interest and penalties. The paperwork alone can be an overwhelming task for someone who is not familiar with it.

Owners of LLCs pay their self-employment tax once a year on April 15 when personal income taxes are normally due. Income tax filings are also relatively easy for the owners of an LLC: A single-member LLC files the same 1040 tax return and Schedule C as a sole proprietor; partners in an LLC file the same 1065 partnership tax return as do owners of traditional partnerships.

Employment taxes are just one aspect to consider when choosing an entity type for your business. There is no one, magical entity that works for everyone. The important thing is to consider the operational, legal and tax aspects of each structure as they apply to your unique situation.