Do S-Corp's provide tax advantages over LLC's?

First of all S-Corp’s are only for US Citizens or Residents, which I asume Lonnie is. Tax wise however there may be a benefit as far as I understand it to S-Corp’s. It is however fairly small, but it might still be worth your while.

You see US Citizens and Residents are liable for 15.3% Self Employment Tax of the first $94,200 self employed earnings per tax year. This is true for Partnership income as well. A LLC is taxed on the federal level as a partnership, thus you have to pay self employment tax of your share of the profits up to that level. The Self Employment Tax is basically FICA for self employed people. It is your Social Security and Medicare all lumped together. If you are still making W2 income I believe you can discount any FICA paid from that etc, but best you read the IRS guidelines yourself in this case.

A S-Corp shareholder receives passthrough income the same way as he would in a LLC or partnership, but is not liable for Self Employment Tax on this. This is where the tax benefit comes in. However, before you all get excited and start incorporating S-Corp’s it’s not quite that simple. An S-Corp requires any shareholder or officer that performs actual work for the corporation to be an employee. This is where the catch is. So you need to setup payroll and all the red tape involved. You also need to pay FICA. Thus immediately you have a much larger work load of red tape.

Now with regards to salary and pass through, you definitely can still provide part of your distributions as regular pass through distributions, however you do need to provide yourself with a reasonable salary unfortunately. The IRS says:

Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.

Now what that means is really a good question. If you are a Rails developer you could probably find out what the lowest startup salary is in your area and stick with that. I’m sure the IRS would prefer you put the whole FICA’able limit of $94,200 as your salary, but I don’t think you need to be that strict. If you do that, there is definitely no reason whatsoever to pick S-Corp over LLC.

You definitely should talk to a real tax advisor and not an abject amateur like me to find out what the real proportion of salary vs passthrough distribution should be.

In the mean time check out the TaxAlmanac which seems to be a great Wiki on US Tax issues as well as the IRS page on this particular issue.