The S-Corp and the S-Corp election are terms you hear all the time but what does it actually mean and what does it do?
You can make an election for your LLC to be treated as an S-Corp for tax purposes by filing the election form with the IRS. Making the election can save you thousands of dollars in taxes every year but only if your business meets certain thresholds and you use it the correct way.
Why Should I Make The S-Corp Election?
The main benefit of making the S-Corp is for the tax savings that it can provide.
Making the election by itself doesn’t make any change in your taxes. You will need to use it the proper way to receive the tax saving benefits.
What are the requirements of an s-Corp?
The S-Corp has 2 main requirements that you must be familiar with.
Reasonable Salary
You are required to pay yourself a reasonable salary as a shareholder of an S-Corp. The salary should be paid with a W2 by running payroll for each year.
The term “reasonable” does not have a quantitative definition but is based on several factors such as position, experience level, and the average salary in your area for a similar position.
We can run a reasonable compensation analysis to come up with the amount as well as have the proper documentation on file.
Annual Business Return Filing
You are required to file a business return on the Form 1120-S by March 15/16th in general as you will have a calendar year-end unless you’ve made an election to have a fiscal year end (not common).
Filing the business return is required even if the S-Corp did not have any activity for the year.
An important schedule from the S-Corp return is required for the personal return. This is called the Schedule K-1.
How does the S-Corp reduce my taxes?
If you don’t make the S-Corp election and remain a single-member LLC, your entire net income is subject to the 15.3% self-employment tax.
Let’s take a look at a simplified example to see what this results in.
Simplified Example – Single Member LLC
$100k in net income
Self-employment tax (15.3%): $15,300
You would have $15,300 in self-employment tax as a single-member LLC in this simplified example.
However, as a shareholder in an S-Corp, you have 2 ways to take money out.
- Salary
- Distribution
The amount you take as a salary is subject to the 15.3% self-employment tax whereas the amount you take in distribution is not subject to self employment tax.
Let’s take a look at another simplified example with the same $100k in net income except as an S-Corp.
Simplified Example – S-Corp
$100k in net income
Salary: $50,000
Distribution: $50,000
Self-employment tax on salary: $7,650.
Your self-employment taxes on the same net income as an S-Corp would be $7,650 compared to the $15,300 as a single-member LLC giving you tax savings of $7,750.
Note: These are over-simplified examples to show the tax-saving concept and the actual calculations differ in practice.
When Should i consider making the S-Corp election?
You should consider making the S-Corp when your net income is around $60-$70k.
An S-Corp can help you decrease the self-employment taxes you pay but there are some additional organizational and administrative costs that is required.
The tax savings from making the S-Corp election will need to exceed the various administrative costs such as payroll fees, QuickBooks or similar, franchise fees, and business tax preparation fees in order for the election to make sense.
Frequently Asked Questions
How do I make the S-Corp Election?
You can make the election by completing and submitting the Form 2553 to the IRS. All shareholders must sign the form.
What is the deadline to file the S-Corp Election?
You must complete and file Form 2553 no more than 2 months and 15 days after the beginning of the business tax year the election is to take effect. It may also be possible to retroactively make the S-Corp election in certain cases.
How do the filing requirements differ between a single-member LLC and an S-Corp?
A single-member LLC reports the business income and loss on the Schedule C of your personal return. There is no business return required.
An S-Corp reports the business activities on the Form 1120-S. Business activities includes business bank balances, credit card balances, loans, etc.
You will not have a Schedule C unless your S-Corp election has been accepted in the middle of the year.
The S-Corp return will also provide a Schedule K-1 which will be required to accurately file your personal return.