When it comes to your business, there are many things you must consider. The first is to decide if you should register as an LLC, sole proprietorship, or corporation. This article focuses on the tax implications of an LLC and the options you have. Keep reading to find out why you should have your LLC taxed as an S-Corp.
An S-Corp or S-Corporation is a tax entity, whereas an LLC is a legal entity. This means that it is a tax classification option for the LLC. An S-Corp is also a pass-through tax entity, which means you will not see double taxation like C-Corporations do. Any LLC income, losses, credits, and deductions flow through to the owners or shareholders of the S-Corp. This gets reported and paid on their personal tax return. An S-Corp classification ensures that the owners of the LLC have personal liability protection. Thus, their personal assets are protected in the event of a lawsuit, and cannot be seized to pay debts of the S-Corp.
An LLC will have a default tax status with the IRS, however, this varies depending on how many members there are. A single-owner LLC will automatically be taxed as a Disregarded Entity/Sole Proprietorship. But, if you have 2 or more owers, the LLC will be taxed as a Partnership instead. Now, you have the option as the owner of an LLC, to request that the IRs tax you as a corporation instead. All you need to do is fill in a form after getting the EIN for your LLC. You can either choose to have your LLC taxed as an S-Corp by using form 2553 or as a C-Corp by using form 8832. An S-Corp is the best option for small business owners that are earning at least $70,000 per year.
One of the biggest benefits of an LLC with S-Corp tax classification is saving money on self-employment taxes. Typically, with an LLC you would pay 15.3% of your net income to the SSA, which you must then report on your personal federal tax return.
However, as an LLC with S-Corp classification, you become an employee-owner as you both work for and own your company. Now, S-Corp classification saves you money on self-employment taxes by splitting your income into two separate groups; salary and dividend. With this, you now only pay the 15.3% self-employment tax on the salary section. The dividends are not subject to self-employment taxes.
Now, with an S-Corp classification, your LLC must be paying you and any other owners a reasonable salary. Thus, if the average salary in your industry is $50,000, that is the minimum you should be paying yourself. Thus, the minimum you would pay taxes on.
Operating with the S-Corp classification requires administrative work that isn’t needed as a regular LLC. These administrative duties include;
With these responsibilities, it is very beneficial to hire an accountant to check things and file your corporate tax return each year. You may also need to consider additional payroll responsibilities like unemployment insurance at the federal and state level and workers' compensation insurance.
For your LLC to be taxed as an S-Corp, it must first meet a few requirements. These are;
Your LLC must be formed in the United States.
An LLC under the S-Corp tax classification cannot have more than 100 members at any given time.
Your LLC can only have one class of stocks. This means all shareholders or owners receive the same privileges.
Under IRS rules, an S-Corp can only have eligible shareholders or owners.
Even though you can save money on taxes, it is important to consider the disadvantages of having an LLC taxed as an S-Corp. Below are the main disadvantages you may face;
S-Corps are often under closer watch by the IRS, especially to do with the reasonable salary requirement.
Your Social Security benefits are based on your income. Thus, if you opt for a lower salary to save on taxes, you could reduce your future Social Security benefits.
Remember that banks will only look at your income, not the business dividends for a home loan. With this, if you pay yourself less, you may not qualify for a higher loan amount.
As you can see, having your LLC taxed as an S-Corp can help you save money on taxes, while putting more money directly into the business. However, carefully consider all aspects and discuss them with an accountant before deciding. After all, if you are looking to purchase a home in the coming years, an S-Corp may be a disadvantage for your home loan application.
