So if the IRS audits me, they'll say that my work is worth something and therefore, I have to pay taxes on it?
Sounds awful.
But I and the accountants I talked to don't think that's the case.
Also, I'm not going to take R&D credits, nor claim deductions from salary, so why would they care?
And I did the math: yes, an S Corp is technically better. But at the revenue levels I plan on seeing, the difference isn't that much (a few thousand), and any revenue gets taxed right away, which is more convenient for me. I'll take that instead of complicating my taxes.
Well, no...since you're not claiming to be making any revenue from that work, it doesn't matter. Whether you deduct 100% or 20% of your salary from $0 business income you still have $0 of taxable business income (and as an individual you don't get NOL carryovers so that amount is lost to you forever).
In fact, in the event of an audit, you'd likely get a refund since the IRS would determine that you're incorrectly calculating your tax liability by failing to capitalize your R&D expenditure (i.e., your flow-through revenue which is entirely treated as self-employment income). But, because this error affects other years' returns, which means that a one-return audit can turn into a multi-return audit. It also means you get put on a very special list of taxpayers subject to increased scrutiny (meaning, significantly more likely to be audited again in a future year).
But at the revenue levels I plan on seeing, the difference isn't that much (a few thousand), and any revenue gets taxed right away, which is more convenient for me. I'll take that instead of complicating my taxes.
Yes, the LLC is much simpler when it's a disregarded (single-owner flow-through) entity. But it's more complicated once you add other members or any employees. And as you've pointed out, you're already paying more in taxes.
My issue isn't with you choosing to use the LLC form because it's simpler, my issue is with you claiming that it's better for tax purposes on a numerical basis when it is clearly not.
The problem is, as this whole comment section shows, is that is it not clear.
Because it isn't, I decided to go with the simpler option because I don't plan on having employees.
There is no dispute amongst tax advisors about whether a single-owner S-Corp is better than a single-member LLC for tax purposes: the S-Corp is better. Hands down.
But the LLC is simpler because a one-person LLC doesn't exist for tax purposes, it's just an extension of its owner. The cost of this simplicity is significantly higher taxes once you make enough money for taxes to matter.
Whether the S Corp is better than a plain LLC is up to the business owner, and it doesn't just have to be about money.
You are just wrong that an S Corp is better for me. I've done the math, I know the difference, I made the choice with other factors in mind as well.
> There is no dispute amongst tax advisors about whether a single-owner S-Corp is better than a single-member LLC for tax purposes: the S-Corp is better. Hands down.
Funny thing is that one of the three accountants I went to disagreed with this, so it's definitely not "hands down."
The LLC is only better so long as it remains a disregarded tax entity with no employees, because once either of those happens, it becomes significantly more complex than an S-Corp. So if you're fine not ever having partners or employees, and paying more in taxes for the sake of slightly more simplicity, then yes, the LLC is better.
But if you want partners, or employees, or saving money on your taxes, then the S-Corp is better. And if an accountant is telling you otherwise, then it's only because you make so little money that it doesn't matter whether you have a legal entity or not.
A single-member LLC and a single-member S-Corp are taxed largely the same on the revenues of their entity, in the sense that they're both essentially flow-through entities for a solo entrepreneur. From a tax perspective, an S-Corp is better than an LLC for 99% of solo entrepreneurs because if you have enough revenue, you can take some of it as qualified dividend which is taxed at a lower rate than directly passed-through income.
So if I went the S Corp route, I'd actually have to pay taxes on 0 revenue.
This is false. The income tax on $0 revenue (meaning no revenue, not no profits) is the same: $0. (Note, however, that many states have "fees" assessed on business entities like S-Corps and LLCs, even single-member LLCs, and in such cases a minimum fee is owed regardless of revenue.)
But as a regular LLC, my own work (as the owner) does not count as anything taxable, so I'm safe.
This is also false. The work you provide to the entity as an owner is still an R&D expenditure. The difference is that with the S-Corp, the expenditure cost is clearly documented, while with the LLC you're pretending that the number is $0 and gambling on not getting audited. This only matters once you start generating revenue...
Either way, not all of your salary would be subject to capitalization. If you have revenue, you clearly spent at least some time and work on marketing and business development, and expenses for those non-R&D activities are not capitalized.
On a further note, with the S-Corp, your salary offsets up to [your salary assigned to non-R&D tasks less 1/5 of your salary assigned to R&D] in revenue each year, and after an appropriate amount of salary (generally the SSI contribution threshold for the year) the rest of that annual revenue can be repatriated to yourself as a dividend at lower tax rates. With the LLC form, since you aren't paying yourself a salary, you owe tax on 100% of the revenue arising from the software you develop without any deductions. And it gets entirely taxed as regular income. Worse, it's self-employment income, meaning that in any realistic situation, you're paying a higher effective tax rate with the solo LLC form.
TLDR: If you actually care about tax, S-Corps are almost always the better option, and they're still the better option here.