The primary benefit that attracts many business owners to become an S Corp for tax purposes is straightforward—it can potentially save them money.
However, before making any changes to (or forming) a business entity that will have legal or tax implications, entrepreneurs should weigh all pros and cons with a tax advisor and attorney. There are many factors to consider when altering a business structure or how taxes are handled.
The information that I will share in this article is not meant to be legal or tax advice but rather some general information about the possible benefits of forming an S corporation and how to become an S Corp. I’m going to focus on what’s involved in converting an LLC to an S Corp, and then I’ll touch on converting a C Corp to an S Corp. (Sole proprietorships and partnerships must first form an LLC or incorporate before they can elect for S Corp tax treatment.)
LLCs and S Corp election
By choosing S Corporation election with the IRS, LLC owners reduce their self-employment tax liability. The IRS treats both the LLC and S Corp as pass-through tax entities, but there’s a difference in how compensation is paid to owners.
Generally, with the LLC structure, LLC owners (members) pay themselves through owners’ draws. But by electing S Corp tax treatment and putting themselves on the company payroll, LLC members can lower their self-employment tax burden. Rather than paying federal income tax and self-employment tax on all of the company’s taxable income (as is the case with a sole proprietorship, partnership, or LLC), an S Corp’s owners only pay self-employment taxes (Social Security and Medicare) on their wages and salaries. The remaining business profits, paid to owners as distributions, are not subject to self-employment taxes.
To be taxed as an S Corp, an LLC must…
- Put their owners on the company payroll.
- File the necessary IRS forms to become an S Corp.
1. Put LLC members on the company payroll
As I mentioned before, an S Corp must partially pay its owners through wages and salaries, which need to be at a reasonable rate for the market. Setting up payroll to have all taxes withheld and reported correctly can get a bit involved and confusing. You may consider payroll software to streamline your payroll responsibilities.
2. File the necessary IRS forms to become an S Corp
To get the benefits of an S Corp, an eligible LLC can apply for the election without changing its organizational structure to a corporation. That means its owners can reduce their self-employment taxes without taking on the extensive ongoing compliance requirements of a C Corp.
One way to ensure the paperwork gets completed correctly and on time is to use the services of an online document filing company, like CorpNet.
C Corp and S Corp election
C Corps already have payroll set up, so the S Corp benefit to them is avoiding double taxation. With usual C Corp tax treatment, the entity pays federal income tax on its income after allowed deductions, credits, etc. Then, the profit distributions it makes to shareholders (which aren’t tax-deductible business expenses) get taxed again at the individual shareholder level.
As an S Corp, the entity doesn’t pay income tax but rather the corporation’s profits pass through to its shareholders’ personal tax returns instead, thus eliminating double taxation.
To elect S Corp tax treatment, a corporation must submit IRS Form 2553. Again, consider opting for an online document filing company’s services.
How long does it take?
The interval for having S Corp election processed depends on whether the company is an existing LLC or corporation or a brand new entity that wants to file for S Corp election.
The state where the company is registered can affect the timeline, too. The processing period can range from two to 30 days. Sometimes, online filing companies offer a rush option.
Nellie Akalp is a passionate entrepreneur, small business advocate and mother of four. She is the CEO of CorpNet.com and recently launched a partner program for the accounting community. Accountants, CPAs, Bookkeepers and other professionals can offer business incorporation and annual compliance services to their clients to extend their services, while CorpNet does all the work.
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