If you have a limited liability company (LLC), electing to tax it an S corporation could be helpful. Numerous factors could help your decision. How do you treat your income? Will you use some of it as dividends? We’ll take a look at some of the pros and cons of an LLC taxed as S corp and see if it’s right for your business.LLC Benefits
The LLC business entity has some appealing advantages over its alternatives. They include:
When an LLC opts for an S corporation tax structure, it typically changes the way the IRS treats that LLC’s income.
When income from LLCs passes through to owners, they pay tax on it as self-employment income. The self-employment tax comes to 15.3%, with Social Security representing 12.4% and Medicare tax representing 2.9%.
As anyone who’s checked their pay stub knows, self-employment taxes are higher than Social Security and Medicare taxes paid by workers who aren’t self-employed. As a result, employees withhold just 6.2% for Social Security and 1.45% for Medicare. That’s because employers pay another 6.2% for Social Security and 1.45% for Medicare without passing it onto employees. Self-employed people pay both halves.
There are two more key factors to consider here:
By having LLC treated as an S Corp for tax purposes, a business owner may save a considerable amount in tax payments.How LLC Taxed as S Corp Works
Say you are sole member of an LLC that earns $100,000 in net income. All $100,000 will pass through to you as self-employment income. In addition to income taxes, you’ll owe self-employment tax of $15,300, or 15.3%.
If you have elected be taxed as an S corporation, you might have $50,000 pass through as earnings and $50,000 distributed as dividends. Then you’d owe just $7,650 in self-employment tax, for a tax savings of $7,650.
Another potential advantage of an S corporation is that the Tax Cuts and Jobs Act made certain pass-through businesses eligible for a 20% Qualified Business Income deduction. This can produce additional tax savings not available to C corporations.
These potential tax benefits are the main reason LLCs elect to be taxed as S corporations.Choosing LLC Tax Status
An LLC can choose an S corporation tax structure because an LLC is a business entity defined by state law. Meanwhile, S corp describes how the IRS treats a business for tax purposes. If the LLC doesn’t choose, the IRS applies a default tax structure depending on the number of members of the LLC.
An LLC can choose to be treated as an S corporation in a two-step process:
Despite the potential benefits, S corporation status for an LLC isn’t a no-brainer. First, not all LLCs are eligible for S corporation status. Only U.S. corporations with no more than 100 owners, all of whom are U.S. residents, can choose S corporation status. Plus, they can only have a single class of shareholders. These restrictions can prevent an S corporation from attracting investors.
There are also added administrative costs. S corporations have extra recordkeeping and meeting requirements compared to sole proprietorships. However, the paperwork burden is lighter than for C corporations.
Meanwhile, earnings determine caps on annual IRA or other retirement plan contributions. So the more you take in dividends, the less you can put into a tax-advantaged plan.
S corporations are also somewhat more prone to IRS. audits And, if the IRS determines you aren’t paying yourself a reasonable salary, it may reclassify some dividends as earnings. Then you might owe self-employment tax plus penalty and interest on those.The Bottom Line
The S corporation is the only business tax status that lets you save on Social Security and Medicare taxes while avoiding double taxation. An LLC taxed as S corp offers benefits of a corporation while also providing flexibility on income treatment. If you want to operate on the most bare-bones, tax-stingy structure possible, an LLC taxed as S corp may be right for you.Business Tips
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