LLC vs. S-Corp: Which is Better for Real Estate Agents?

LLC vs. S-Corp for real estate agents: the pros and cons of an S-Corp and how to have BOTH an LLC and S-Corp for maximum flexibility.

Introduction

Many self-employed real estate agents have wondered if an LLC vs. S-Corp is better for their business.

In today’s post, I’m going to explain why an S-Corp is advantageous, and when to make the election. 

I’ll also explain when an S-Corp is a bad idea and other ways for real estate agents to lower their tax bill. 

I’ll also show you how to have BOTH an LLC AND an S-Corp for maximum protection and flexibility. 

DISCLAIMER: Remember, none of this is meant to provide individualized advice, so consult a tax professional for help regarding your unique situation.

Are you ready? Let’s go!

Table of Contents

Difference Between LLC and S-Corp

Sole Proprietors and LLCs

Most business owners begin their journey as a sole proprietor, with no formal setup. 

All income and expenses are reported on Schedule C of the owner’s individual tax return or 1040. There is no legal protection for personal assets if the business owner goes bankrupt or gets sued. 

Once a business owner decides to become a Limited Liability Company (LLC), they need to register their business in their home state and pay an annual fee. 

The LLC offers legal protection for a business owner’s personal assets against creditors and lawsuits.

The LLC is a LEGAL status and NOT a tax status. Any advice about LLCs should be provided by a business attorney. 

Accountants can help you with the setup or maintenance of an LLC, but always consult a lawyer for LLC advice in the beginning. 

One-owner LLCs are taxed exactly the same way as a sole proprietor, unless they elect to become a corporation. 

LLCs with multiple owners are taxed as a partnership, and must file a 1065 partnership tax return, unless they elect to become a corporation.

Subchapter S-Corporation

The IRS code allows LLCs to change their tax treatment from sole proprietorship to S-Corporation by filing a form 2553 in the first couple months of the tax year. 

The S-Corporation is meant for smaller businesses with fewer than 100 domestic shareholders, no corporate owners, and only one class of stock. 

The biggest difference from an LLC is that shareholders do not pay self-employment taxes on their Schedule C. In fact, S-Corp owners do not file a Schedule C at all! 

S-Corps are required to file a corporation income tax return called an 1120-S. Each owner receives a form K-1, or distributive share of income to report on their own tax return. 

Owners are also required to pay themselves a reasonable W2 wage.  This is how S-Corp owners pay self-employment taxes. 

What are self-employment taxes?

There are many different types of taxes in the United States, such as income tax, property tax, sales tax, excise tax, payroll tax, and more. 

When you work for someone else, your income taxes are estimated and withheld from each paycheck throughout the year. Your payroll taxes are also withheld from each paycheck and sent to the government. 

Income taxes vary depending on how much you make. Overpayment of income taxes comes in the form of a tax refund. Underpayment will result in a balance owed. 

Payroll taxes are a percentage of your paycheck, and these never get refunded. Sad, I know! 

Payroll taxes are ALSO called self-employment tax, SE tax, FICA tax, or Social Security and Medicare tax. You may even see them on your paystub as “OASDI” or simply “Med.” It’s confusing, but these all mean the same thing!

For simplicity, I will refer to them as payroll taxes. 

Payroll taxes consist of the following:

  • Social Security: 6.25% of wages for the employer, plus 6.25% for the employee, for a total of 12.5% up to $135,000 each year (then it’s 0%)
  • Medicare: 1.45% for the employer and 1.45% for the employee for a total of 3.0% (with no cap)
  • Federal Unemployment: This is only paid by the employer, and the rate varies. Usually capped at $42 per employee, per year.
  • State Unemployment: This is also only paid by the employer, and the rate varies based on how frequently employees file for unemployment benefits. ,

How Does Becoming an S-Corp Save on Payroll Taxes?

LLC Tax Calculation

For sole proprietors and single-member LLCs, you pay payroll taxes on 100% of your net profit at the end of the year. 

If you make $100,000 in profit, you’ll pay around $15,000 in payroll tax, on top of your income tax. 

Income Tax = Tax Rate * Profit

Payroll Tax = 15.3% * Profit 

Total Tax = Income Tax + Payroll Tax

S-Corp Tax Calculation

S-Corp owners only pay payroll taxes on their W2 salary taken from the business. Often, this CAN be less than the total profit, thereby reducing the total amount of payroll taxes compared to an LLC. 

Income Tax = Tax Rate * (Profit + Wage)

Payroll Tax = 15.3% * Wage 

Total Tax = Income Tax + Payroll Tax

The S-Corp is Not a One-Size-Fits-All Solution

As you can see, the total tax liability for an S-Corp is less than an LLC or sole proprietor. 

However, this is ONLY the case if the total profits are significantly HIGHER than a reasonable wage. 

So an LLC owner making $50,000 in profit would NOT benefit from an S-Corp. They would pay the same amount in taxes and additional accounting fees to pay for the S-Corp tax returns. 

Usually, the benefit of an S-Corp comes in around $75,000 in consistent profit. However, it depends on the industry and level of expertise of the business owner in addition to utilization of other tax savings strategies. 

It’s NOT a one-size-fits-all answer. 

Top 10 Reasons NOT to Become an S-Corp

1. Less than $75,000 in Net Profit

In most scenarios, it doesn’t make sense to elect S-Corp status unless you make at least $75,000 in profit (after expenses). 

This is because the payroll tax savings is not typically offset by the additional costs and complexity of running the S-Corp. 

Sometimes, if your business can justify an extremely low salary, and you can manage your own payroll, it *may* be worth it. 

Otherwise, it’s often better to fully utilize the QBI deduction, max out your Solo 401(k), hire your children, or simply focus on increasing your profitability. 

2. Foreign Owners or More than 100 Shareholders

If any of the business owners are foreign entities, corporations or partnerships, you can’t elect to become an S-Corporation. It’s simply against the IRS rules. 

3. Inconsistent Income

If you make inconsistent profits from year to year, you may want to wait until you can consistently make at least $75,000 per year before becoming an S-Corp. 

Again, this is not a hard and fast rule – but it’s a helpful guideline for new real estate agents. 

4. You are a Real Estate Investor or Property Owner

Never put real estate in an S-Corp. It comes with a hidden tax issue. 

If you are a landlord, you’ll need to keep your property as a sole proprietor or LLC. 

Consult a real estate attorney for more advice on how to structure your rental properties. 

5. You Want to Pay Your Children

S-Corp owners can’t utilize hiring their own children as a tax savings strategy. 

LLC owners can hire their own children to shift income to their kids without incurring income or payroll taxes. 

S-Corp owners can’t do this, because they would need to pay payroll taxes on the child’s income, which would negate the benefit.

Some S-Corp owners circumnavigate this limitation by setting up a separate LLC to pay family members.  

6. You Plan to Maximize Your Solo 401(k)

LLC owners can save on taxes by maximizing employer contributions to their solo 401(k). They can defer taxes on 25% of profit. 

S-Corp owners can only defer 25% of the W2 wages, which is a smaller number. 

Depending on your circumstances, you might save more by maxing out employer contributions to a solo 401(k) instead of becoming an S-Corp.

You’ll be deferring instead of eliminating taxes, but you’ll also benefit from the growth of your retirement account. 

Keep in mind that the employee contributions to a Solo 401(k) are available up to the annual limit, in addition to employer contributions, regardless of profit level, which makes the solo 401(k) an extremely valuable tool for business owners. 

Ask your tax accountant for a comparison! 

7. You Need to Take a Large Reasonable Salary

S-Corp owners MUST take a salary every year based on their skill level, training, geographic area, and a number of other factors. 

A reasonable salary isn’t an exact science, but the IRS can recategorize your income as wages if you set your salary too low. 

Too low of an S-Corp salary invites IRS scrutiny! 

If you are a skilled attorney, doctor, veterinarian, or even an experienced Realtor, you may need to take a large reasonable salary. 

This makes the benefit of an S-Corp election go down. 

However, if you make a profit of $2M per year, and take a salary of $200,000, you’ll still benefit tremendously. 

The only way to know is to ask your tax accountant for a scenario analysis. 

If you make a small amount of profit, you must take it as a salary before OR leave the money in the business. The IRS will recategorize distributions as wages if you paid yourself without taking a salary. 

8. The Cost Outweighs the Benefit

S-corporations have much higher costs than LLCs.

Additional costs and considerations of an S-Corp vs. LLC:

  • Cost to File S-Corp Election
  • 1120-S Tax Return
  • K-1 Issuance to Owners
  • Owner’s Payroll Runs (Depends on Frequency)
  • Quarterly Payroll Tax Returns
  • New bookkeeping records
  • Clear tracking of distributions
  • Annual Payroll Tax Returns and W2s

On average, S-Corp owners spend about $2,500 – $5,000 more than LLC owners on company administration.

If the tax savings is less than the added cost, it doesn’t make sense to become an S-Corp. 

9. You Value Simplicity and Want to Avoid Scrutiny

With all of those additional responsibilities, you may want to keep it simple and avoid the S-Corp altogether. 

It can also keep unnecessary IRS scrutiny at bay. 

As a side benefit, if you pay more payroll tax, you’ll have more social security to draw from when you retire (but don’t let that be your sole motivation!)

10. You Want Unequal Distributions for Owners

With an S-Corp, you must distribute profits after wages to each owner based on their ownership percentage. 

Some businesses do not want this limitation. 

For example, you might have two partners who own the business 50/50. One owner wants to get paid their share of the year’s profits, and the other owner wants to reinvest the profits back into the business. 

With an S-Corp, this DOES NOT WORK. Both owners MUST take an equal distribution relative to their ownership percentage. 

When Should I Make an S-Corp Election?

With all of the limitations discussed above, does it ever make sense to become an S-Corp?

The answer is… ALL THE TIME! 

Many self-employed real estate agents can save $10,000 or more each year just by becoming an S-Corp and changing nothing else. 

But you’ll need support from a good attorney and a good accountant. 

I am a CPA that specializes in bookkeeping and payroll for Real Estate Agents and Brokerages. While I don’t prepare taxes, I can help you determine if the S-Corp is worth it, and help you ensure your reasonable salary is taken correctly. 

I also work with your tax preparer to ensure a seamless transition from LLC to S-Corp. 

The S-Corp election must be made by March 15th of the current tax year, but occasionally, the IRS may accept a late-filed election. 

If you do not yet have an LLC, you will need an LLC first before you can elect S-Corp status, and you won’t be able to make a late election.

How to Have BOTH an LLC and an S-Corp at the Same Time

Many business owners start with an LLC, and then change the LLC to an S-Corp at a later time. 

An alternative strategy is to KEEP the LLC, create a second one, and elect S-Corp status for the second LLC. 

The first LLC will pay management fees to the S-Corp, and the S-Corp will pay the owner a reasonable salary. 

The first LLC will also be able to pay the owner’s children for legitimate work, which is a viable tax savings strategy by itself. 

This provides some flexibility in allocating earnings – but I am not an expert on this method. This is an advanced strategy that you should ask your CPA or attorney about setting up for you. 

The downside of this method is that two legal entities are required, which increases complexity, adds additional filing and accounting fees, and requires separate books, accounts, and records (i.e. multiple software accounts, different payroll bank accounts, etc.)

Conclusion

Real estate agents and other business owners can benefit from electing to become an S-Corp. They save money on taxes by reducing the overall amount of payroll tax (Social Security and Medicare) paid by the owner. In some cases, the savings can be significant, totaling tens of thousands every year.

However, S-Corp owners have additional tax filing requirements, potential IRS scrutiny, and additional accounting costs. They will reduce the overall amount of social security funds to draw from in their retirement. 

LLC owners can find other ways to save on taxes, like maxing out their Solo 401(k) or paying their children to work in their business. 

An advanced strategy might involve a combination of both an LLC AND an S-Corp, although having two companies would require more filing and accounting fees as well as separate bookkeeping. 

How I Can Help

I am a former tax accountant who helps real estate agents and brokers create bulletproof books and implement sound payroll strategies. 

I help real estate office keep track of commissions, caps, 1099 payments, property management, and more. I’ll work with your tax preparer to ensure that you always have everything ready for a seamless, stress-free filing. 

I also review your books every month to help you make better decisions, understand your margins, and ultimately, take HOME more money. 

If you need a new bookkeeper or CFO for your real estate business, get started today.