LLC with S-Corp Status: Could It Help You Save On Taxes?

In the complex world of taxes, there's a strategy that freelancers, small business owners, and 1099 contractors might be overlooking: the option to tax your LLC as an S-Corp. Not sure what this means? Don’t fret. We'll dive deep, explaining how this tax choice could put more money back into your pocket.

LLC vs. S-Corporations: What’s the Difference?

First, let's start with the basics.

An LLC (Limited Liability Company) is a type of business structure. When you set up an LLC and do nothing else, the IRS views your business as a sole proprietorship for federal income tax purposes. 

In simple terms, a sole proprietorship is the default tax classification of a single member LLC. You earn money, take out your business costs, and whatever's left (your LLC’s profit) gets reported on your personal tax return.

On the other hand, an S-Corp isn’t a business type but a tax status. It’s all about how the IRS sees your earnings. With an S-Corp, you draw a salary from your business. Only this salary is subject to self-employment tax, not the entire business profit.

What is an LLC with S-Corp Status?

Marry the two above, and you have an LLC with S-Corp tax status. Here’s how it works.

When your LLC elects to be taxed as an S-Corp, you, as the owner, pay yourself a “reasonable salary,” as defined by the IRS. This salary is subject to self-employment taxes (Social Security and Medicare). After paying your salary, any remaining profits can be taken out as “distributions.”

You pay regular income tax and self-employment taxes on your salary, just like any other employee. The remaining distributions you take out (after your salary) are taxed at your individual income tax rate, but without additional self-employment taxes.

For example, imagine your LLC (taxed as an S-Corp) makes $60,000 in a year. You decide a reasonable salary for your work is $40,000. You will pay income tax and self-employment taxes on this $40,000. The remaining $20,000 can be taken as a distribution. You only pay income tax on this $20,000, potentially saving you money!

Advantages of an LLC Taxed as an S-Corp

So, why should you tax your LLC as an S-Corp? Here’s the lowdown on the advantages of S-Corp election:

• Tax savings: The main benefit of going the S-Corp route is that it can potentially lower your taxes. Remember the salary and distribution bit? You only pay payroll taxes on the salary, not on distributions. If your business makes a good profit, this could mean less taxes.

• Limited liability protection: Like all LLCs, you get liability protection. This means your personal stuff (like your house or car) is generally safe if your business runs into legal issues. 

• 20% pass-through deduction: An LLC taxed as an S-Corp can also benefit from the 20% pass-through deduction, known as the Qualified Business Income Deduction (QBI). Introduced by the Tax Cuts and Jobs Act in 2017, this allows business owners to shave off up to 20% of their business profit from their income taxes. 

Disadvantages of an LLC Taxed as an S-Corp

While the advantages are appealing, it’s important to note that being taxed as an S-Corp may not be for everyone, since it depends on the business’s total income and the state you’re in. There are some cons to bear in mind if you’re considering an LLC with S-Corp status:

• Lots of paperwork: Switching to an S-Corp means more paperwork and greater IRS scrutiny. There are additional forms, more complex tax filings, and stricter record-keeping requirements. This can be a headache if you're not a fan of red tape.

• Can be expensive: Yes, there are tax savings, but don’t forget the costs. There might be state fees for the S-Corp election, and you might need a professional like a Certified Professional Accountant, CPA, to handle the extra paperwork. This can add up, so weigh the pros and cons carefully.

Additionally, you can't just pay yourself a tiny salary to dodge taxes. The IRS is onto that game. Your salary needs to be "reasonable" or market rate for what you do. If you're a graphic designer making $100,000 in profit, you probably can't pay yourself $20,000 and call it a day. 

How to Get Your LLC Taxed as an S-Corp

If you’re considering the switch to S-Corp status for your LLC, you’ll generally follow these steps:

1. Form an LLC: If you haven’t, start by forming an LLC. Each state has its own rules, so check yours.

2. Apply for an EIN: Next, you’ll need an Employer Identification Number from the IRS. You can get your EIN on the IRS website. It’s free.

3. File Form 2553: Filling out Form 2553 is how you elect S-Corp taxation for your LLC. The deadline to file is usually two months and 15 days after the beginning of the tax year.

4. Follow state regulations: Some states may require additional forms. Check your state’s requirements for S-Corp taxation and submit any necessary paperwork.

5. Operate as an S-Corp: Once approved, operate your LLC following S-Corp rules. This includes taking a reasonable salary and keeping meticulous records.

Always check with a tax professional to ensure you're hitting all the marks. It might seem like a lot, but with careful planning, the transition can be smooth.

How Does an LLC with an S-Corp Election File Taxes?

Filing taxes with an S-Corp status is a tad more complex than a standard LLC because you’ll need to file two returns: one business and one personal. Here's a snapshot of the process:

• File Form 1120S: Form 1120S is the income tax return for S-Corps. It reports all income, deductions, and credits of the corporation.

• Issue yourself a W-2: Pay yourself a reasonable salary and issue a W-2. The salary is subject to employment taxes.

• File your personal tax return: Include your W-2 information on your personal tax return.

With a regular LLC operating as a sole prop, you'd only file a single tax return. But because of your S-Corp tax status, it introduces these extra steps. 

Given the complexity of filing taxes as an S-Corp, it's often wise to outsource this task. A tax professional can ensure you comply with all IRS requirements and help you take advantage of all the self-employed tax deductions you might qualify for. 

Should Your LLC Elect S-Corp Status?

This is the million-dollar question, and the answer? It's not one-size-fits-all. If your business is just scraping by or running at a loss, an S-Corp tax status might not be your golden ticket. But if you’re enjoying a nice chunk of profit, the tax savings become pretty appealing.

Here’s what to consider:

• How much do you earn? If your business earns a profit, you could save money by electing this tax status. If your business earns a profit, you could save money by electing this tax status. If your business doesn't earn enough profit, then the costs can outweigh the benefits. The amount of profit you need for an S-Corp to be worth it varies by state, so you should understand how your state taxes S-Corps as part of your decision process. 

• How much admin are you comfortable with? Running as an S-Corp requires more paperwork, like payroll tax filings, even if you're the only employee. More forms mean more compliance responsibilities. Are you comfortable handling it yourself or outsourcing it to a professional? 

• How much will it cost to set up and maintain? Depending on where you live, there might be additional fees associated with setting up and maintaining an S-Corp status. Don't just look at potential tax savings—factor in these costs too.

Before taking the leap, weigh these factors carefully and seek legal advice from a tax professional to determine if this tax status is the right path for you. Even if you don’t work regularly with pay a Certified Professional Accountant, many CPAs will offer one-time consulting calls to help you determine what the right fit for your business is. It’s likely a worthwhile investment if you’re weighing the pros and cons. (As an added bonus: That consultation fee is likely a tax-deductible expense!)

Manage Your LLC’s Finances With Found

The world of LLCs and S-Corps might seem dense, but it boils down to a simple concept: how do you want to be taxed? Making the switch can help you save on taxes, but it also comes with its own set of challenges. Talk to a tax professional who can help you crunch some numbers and decide if an LLC taxed as an S-Corp is right for you.

Looking for an efficient way to manage your LLC’s finances? Enter Found. This all-in-one banking platform effortlessly handles bookkeeping, tracks tax deductions, and even create an Owner’s pay pocket for your distributions.

Have an accountant? No worries! With Found, bid goodbye to endless back-and-forths and tangled financial data. Sharing essential info with your bookkeeper or accountant is a breeze, ensuring they get real-time access to account activity, profit and loss reports, and tax documents. Sign up for free today and discover the financial sidekick you've been missing.

The information on this website is not intended to provide, and should not be relied on, for tax advice.