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Are you an LLC owner thinking about electing to be taxed as an S Corp? If you're still not exactly sure what is an S Corp v. C Corp, or are unaware about how an LLC can be taxed as an S Corp, check out our LLC, S Corp, or C Corp comparison guide for more insights.
This guide assumes you're trying to decide whether to be taxed as an S Corporation or to keep the default tax status. We'll go over the benefits and drawbacks, and give you a really easy rule of thumb at the end to apply to your business.
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An LLC by default (meaning -- if you don't do anything) is taxed as either a:
But, LLC's have the ability to elect, with the IRS, to be taxed as either an S Corporation or C Corporation, or to remain taxed as the default.
There are several benefits to electing S Corp status for your LLC, including:
Lower self-employment taxes: When an LLC is taxed as a pass-through entity, the members are subject to self-employment taxes on their share of the business profits. By electing S Corp status, the members can pay themselves a salary and only pay self-employment taxes on that salary, potentially saving money on taxes.
Tax savings on profits: With S Corp status, the business itself pays taxes on its profits at the corporate tax rate, which can be lower than individual tax rates. This can result in tax savings for the business and its members.
Limited liability protection: As an LLC, your personal assets are already protected from business liabilities. Electing S Corp status does not change this protection.
Here are some of the drawbacks to consider, including:
Additional paperwork and expenses: Electing S Corp status requires filing additional paperwork with the IRS and may require the help of a tax professional. There may also be additional expenses associated with maintaining S Corp status.
Restrictions on ownership and distribution: S Corps have restrictions on ownership and distribution of profits, which may not be ideal for all businesses.
Possible double taxation: If the S Corp distributes profits as dividends, the members may be subject to double taxation, meaning they pay taxes on the profits at both the corporate and individual levels.
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For most new LLCs, it makes more sense to keep the default tax status initially. Explore our Sole Proprietorship vs. LLC guide to help with your decision. It's a bit simpler, and odds are you won't get the tax benefits of S Corp Status. However, if you know you're going to make $100,000 or more the first year and you're the only owner and have no employees, then an S Corp Election probably makes a lot of sense.
First some background. When you make the S Corp election, you'll need to pay yourself a salary that is taxed with self-employment taxes. The salary has to be at "market value."
So, if you would make $60,000 with your job in the "real world," and you have expenses of another $20,000, then you'd have $20,000 in profit. On those $20 in profit, you can avoid the self-employment taxes (15-20% of the profit). This means that you'd save $3,000 to $4,000 a year in taxes.
Most people initially don't have a profit though, in which case the S Corp election is just more paperwork.
Also, you can always elect S Corp election in your second year, third year, etc. once you start to become profitable.
To be an S Corporation, you need to:
Need more information on S Corps? See our LLC vs. S Corp comparison for a more detailed look.
To become an S corporation, the LLC must submit Form 2553 Election by a small business corporation signed by all the members. See the Instructions for Form 2553 for all required information and to determine where to file the form. Proper business structure agreements, like an S Corp operating agreement, ensure smooth operations.
The biggest question now is, "Do you need a lawyer to start a business?” For most businesses and in most cases, you don't need a lawyer to start your business. Instead, many business owners rely on Legal GPS Pro to help with legal issues.
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Chris Daming, J.D., LL.M. : Aug. 6, 2024
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