Should I tax my LLC as an S corp or C corp?
If you run an LLC, it's automatically taxed as a sole proprietorship or partnership, but you can elect to be taxed as a corporation instead. S Corp is the more likely choice for an LLC, while C Corps are usually corporations.
Single layer of taxation: The main advantage of the S corp over the C corp is that an S corp does not pay a corporate-level income tax. So any distribution of income to the shareholders is only taxed at the individual level.
Some LLC owners save money on self-employment taxes by electing S-corp taxation. This is because as an S-corp owner, you don't have to be self-employed–you can become an employee of the company and pay yourself through regular payroll.
In general, you'll want to consider electing S-corp tax status for your LLC if your business is generating sufficient profits to pay a reasonable salary to the members and annual distributions.
The tax benefit for S corporations is that business income, as well as many tax deductions, credits, and losses, are passed through to the owners, rather than being taxed at the corporate level.
Greater tax benefits.
C corps offer better tax advantages due to an increased ability to deduct employee benefits. C corps may also provide tax savings if the corporation is not making income distributions to shareholders or the corporate tax rates are lower than personal rates.
Examples of S Corp tax savings
You need to earn at least $40,000 in profit for an S Corp to make sense, though. Otherwise, the costs of forming and running it exceeds the benefits of an S Corp. Here are some charts that show the tax savings for businesses with $40,000, $80,000, and $100,000 in profit.
File as an S corporation
LLCs have the option of filing as an S corp., the main benefit of which is it provides a mechanism for reducing self-employment taxes. Under an S corp structure, the owner of an LLC can be considered an employee and receive a salary.
S corporations may have preferable self-employment taxes compared to the LLC because the owner can be treated as an employee and paid a reasonable salary. FICA taxes are withheld and paid on that amount.
S-Corp election lets you split your profits into “shareholder wages” (subject to 15.3% self-employment taxes) and “distributive share” (NOT subject to 15.3% self-employment taxes). Active owners in an S-Corp must pay themselves a reasonable salary, but realize a 15.3% savings on the rest of their retained profits.
Can I change my LLC to S corp anytime?
You can make the election valid for the current tax year, which will be reflected in next year's return, by filing Form 2533 no more than two months and 15 days from the start of the company's tax year. All members of your LLC must consent to the election at the time of filing Form 2553 and sign the form.
The S corporation is the only business form that makes it possible for its owners to save on Social Security and Medicare taxes. Historically, this has been the main reason S corporations have been popular. Example: Mel forms an LLC to operate his Bitcoin mining business and elects to have it taxed as an S corporation.
The 60/40 rule is a simple approach that helps S corporation owners determine a reasonable salary for themselves. Using this formula, they divide their business income into two parts, with 60% designated as salary and 40% paid as shareholder distributions.
LLC owners must pay self-employment taxes on all profits, which can be higher than the taxes paid by S corp shareholders. In some states, LLCs have a limited lifespan and may need to be dissolved after a certain period of time or after a specific event, such as the death of an owner.
Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income.
Cons. C corporations must register with the SEC upon reaching certain thresholds. They are subject to greater regulation than other business structures, incurring higher legal fees. Shareholders cannot deduct their losses, and business profits are double-taxed as dividends are issued.
Investors generally prefer C corporations.
If you plan to raise money from investors, then a C corporation is probably a better choice than an S corporation. Your investors may not want to invest in an S corporation because they may not want to receive a Form K-1 and be taxed on their share of the company's income.
An S corporation can own 80 percent or more of the stock of a C corporation, which can elect to join in the filing of a consolidated return with its affiliated C corporations. However, an S corporation is ineligible to be a member of the affiliated group and to join in the election to file a consolidated return.
According to the IRS, a 2% S corporation shareholder is someone who owns more than 2% of the company's stock at any time during the year. This also applies to individuals who own more than 2% of the company's voting power. S Corp shareholders include individuals, trusts, or estates.
You may or may not have heard of the S Corp Salary 60/40 rule. The guideline refers to setting reasonable compensation between 60% and 40% of the business's net profits. This guideline is not set by the IRS. It should not be relied on as the only factor when setting reasonable compensation.
Should I pay myself a salary from my S Corp?
As an S Corporation shareholder who is also actively working in the business, you must pay yourself a reasonable salary for the services you provide. This is to ensure that you're paying payroll taxes appropriately and not avoiding Social Security and Medicare taxes (also known as FICA taxes).
The key concept associated with the taxation of an LLC is pass-through. This describes the way the LLC's earnings can be passed straight through to the owner or owners, without having to pay corporate federal income taxes first. Sole proprietorships and partnerships also pay taxes as pass-through entities.
For most businesses however, the best way to minimize your tax liability is to pay yourself as an employee with a designated salary. This allows you to only pay self-employment taxes on the salary you gave yourself — rather than the entire business' income.
The Tax Cuts and Jobs Act (TCJA) added the latest LLC tax benefits. This act allows LLC members to deduct up to 20% of their business income before calculating tax. If you don't choose S corporation tax status for your LLC, members can often avoid higher self-employment and income taxes with this deduction.
Therefore, your limited liability company should still file tax returns even if you didn't make any money. A good rule of thumb is always to file taxes whenever you're confused. If you had no obligation to file, there's nothing to lose.
