An S Corporation (S corp) is a tax classification that corporations and limited liability businesses may use (LLCs).
Being an LLC taxed as a S corporation has tax advantages that might save you money in the proper circumstances.
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What exactly is a S Corp?
An S corp, unlike a limited liability corporation (LLC), partnership, or C corp, is not a legal entity. Instead, it is a tax classification that may be applied to a company. LLCs and corporations may both decide to be taxed as S companies if specific conditions are met.
The Advantages of Being an LLC Taxed as a S Corp
The distinction between an LLC and a S corp is that S corp status permits business owners to be taxed as employees of the company.
Under the correct conditions, this may significantly lower a company owner’s tax burden, saving them on self-employment taxes (social sercurity and medicare).
The LLC’s Default Tax Structure
A single-member LLC is treated as a disregarded entity for tax purposes, but a multi-member LLC is treated as a partnership by default.
Taxes on a Single-Member LLC
A single-member LLC, like a sole proprietorship, is taxed as a disregarded entity by default. This implies that the IRS disregards the structure of your firm and taxes you just like any other person. The money earned by the LLC is recorded on your personal tax return at the end of the year.
Taxes on Multi-Member LLCs
A multi-member LLC is taxed in the same way as a partnership. This implies that LLCs pay no income taxes to the IRS and that all earnings are distributed to the LLC’s members. Members pay the IRS taxes on their individual tax returns.
Entities that pass through
Pass-through entities include both default tax arrangements (disregarded entity and partnership). This implies that the earnings of the firm are not taxed at the corporate level, but are instead passed through to the proprietors.
The owners of pass-through businesses must pay personal income tax on their portion of the earnings. They must also pay self-employment tax to cover both the employee and employer portions of Social Security and Medicare. The current rate of self-employment taxation is 15.3%.
How a S Corp-Elected LLC is Taxed
S corp owners, unlike disregarded companies and partnerships, may save money on employment taxes by allocating profits to members and passive shareholders.
The owner of a S corp is regarded an employee of the firm as long as they have an active part in the day-to-day operations of the business. An S corp’s owners must be given a “reasonable” remuneration (earned income) depending on their position and industry, with the balance of the company’s earnings dispersed as dividends.
For example, Jennifer owns a Single-Member LLC that earns $125,000 per year and is taxed as a S corporation. Jennifer earned a fair salary of $75,000 as an employee. She then grabbed the remaining $50,000 as a business distribution. Jennifer saved $7,650 in Social Security and Medicare taxes since distributions are not subject to employment taxes.
S Corporation Benefits
An S company has a significant benefit over a regular C corporation in that it is not “double-taxed.” Furthermore, since S corps owners are considered workers of the firm, they may save thousands of dollars in employment taxes. Any money left over in the firm at the end of the year might be given as dividends to active shareholders. This reduces the overall tax burden of the company owners.
Disadvantages of a S Corporation
Because it employs a more complicated tax categorization than a single-member LLC or partnership, a S company may attract extra attention from the IRS. This intricacy might lead to additional accounting or reporting errors, which can result in the IRS deducting a company’s S corp classification. If you select this status, you must follow all IRS requirements.
Another downside of S corporation status is that it restricts the number of stockholders your company may have. If you want to attract investors early on in your organisation, it is usually best to start as a C corporation.
Requirements for an LLC to be Taxed as a S Corp
One of the advantages of an LLC is that it has some tax flexibility. While the default tax treatment for an LLC is as a disregarded business or a partnership, your LLC may be eligible for S corp tax treatment.
There are few limits on LLC ownership. In general, an LLC may have an unlimited number of members and no citizenship limitations. Other business entities, such as corporations or other LLCs, may also own an LLC. In contrast, your firm cannot have more than 100 owners to qualify for S corp status, all owners must be US citizens or permanent residents, and no other business organisations may be owners.
What Impact Will the Tax Cuts and Jobs Act Have on My LLC?
Section 199A of the Tax Cuts and Jobs Act of 2017 allows eligible pass-through entity owners to deduct 20% of their income. This effectively implies that your income taxes will be cut by 20%. The law expressly allows for this deduction on qualifying business income, which is the net profit your company makes throughout the year. If you choose S corporation status, the deduction does not apply to earnings distributed as pay. More information on how this may or may not work for your company may be found here.
When Should Your LLC Choose S Corp Status?
Select S Corp Status if:
You’re a successful company owner who knows how much money you make each year.
You are already dealing with the S Corp procedures, including as accounting and payroll regulations.
Even after paying the “fair compensation,” your company earns enough to benefit from S corp classification and save money.
Select Default Tax Status if:
You are a new entrepreneur who is unsure of how much profit you will generate each year.
You don’t want to bother with formalities like accounting and payroll.
Your company does not generate enough revenue to benefit from S corp classification.
How to Choose S Corporation Status for Your LLC
If you already fulfil the ownership criteria, choosing S corp status for your LLC is a reasonably straightforward procedure. If your company qualifies, all you have to do is submit IRS Form 2553 by March 15, and your LLC will be taxed as a S corporation for the current fiscal year.