LLC - Taxed as an S-Corp form proof

LLC Taxed as an S-Corp (Form 2553) IN PARTNERSHIP WITH LEBEAU & ASSOCIATES

LLC Taxed as an S-Corp (Form 2553)

IN PARTNERSHIP WITH LEBEAU & ASSOCIATES

What is an S-Corp? (definition)

S-Corp is short for S-Corporation, also known as an "S Corp", "S Corporation", or "Subchapter S Corporation." . An S-Corporation is different than an LLC or Corporation (C-Corporation) in that it is a "tax entity", not a legal entity formed at the state-level.

The term ''tax entity" means it's a tax classification status made with the IRS.

The S-Corporation election is made with the IRS and then "sits on top of' your legal entity: either your LLC or your C-Corporation.

An S-Corporation is a "pass through" tax entity, so it is not subject to double taxation like a CCorporation. Any income, losses, credits, and deductions flow through to the owners of an SCorporation (called shareholders) and will be reported and paid for on their personal tax return.

Just like an LLC and a C-Corporation, an S-Corporation offers personal liability protection to its owners. Their personal assets (like homes, vehicles, and bank accounts) are protected in the event of a lawsuit and cannot be used to pay off the debts or liabilities incurred by the S-Corporation.

A lot of people use the term "forming an S-Corporation" and this causes a lot of confusion.

"Forming" an S-Corp vs. "Setting up" an S-Corp Again, unlike an LLC or a Corporation, which is a business entity created at the state-level, an SCorporation is a tax entity selection made with the IRS.

Therefore, you can't form an S-Corporation. Instead, you elect to have your already formed entity taxed as an S-Corporation with the IRS.

Meaning, you first need to form an LLC or a Corporation (making the appropriate filing with your state's Secretary of State office), then elect to have that entity taxed as an S-Corporation with the IRS.

I highlighted ''taxed as" because that is the proper verb, not "form" an S-Corp. There is no filing in any of the 50 states to ''form an S-Corp". A better way to refer to this is "setting up an S-Corp".

Again, "forming an S-Corp" simply means taking an existing entity and changing its tax status with the IRS.

Having said that, traditionally speaking, when people say "form an S-Corp", they actually mean form a Corporation (also known as C-Corporation) with the state, then elect for the C-Corporation to be taxed as an S-Corporation by the IRS. However, an LLC can also elect to be taxed as an S-Corporation with the IRS, and is a very common tax classification made by LLCs whose net income begins approaching $75,000 to $100,000 per year.

S-Corp Benefits The primary benefit of an LLC taxed as an S-Corporation is saving money on self-employment taxes.

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LLC Taxed as an S-Corp (Form 2553)

IN PARTNERSHIP WITH LEBEAU & ASSOCIATES

Self-employment tax refers to Social Security and Medicare taxes, which total 15.3% of your net income (income minus expenses). The breakdown is 12.4% for Social Security tax and 2.9% for Medicare tax.

These taxes are paid to the Social Security Administration and you'll report self-employment tax as a part of your personal federal tax return (Form 1040) on Schedule SE.

The way an S-Corporation saves money on self-employment taxes is by "splitting your income" into two groups:

? Salary (also called wage or payroll) and ? Distribution (also called dividend or profit)

Once your LLC is taxed as an S-Corporation you become an "employee-owner" (also referred to as a "shareholder-owner"). You both own your company and work for your company.

With this "income splitting", you only have to pay the 15.3% self-employment tax on your salary. Your extra money left over ( called distributions) is not subject to self-employment tax.

This is unlike an LLC taxed as a Sole Proprietorship or Partnership. In these tax classifications, you pay self-employment tax on all of your net income and there is no option to split your income and save money on self-employment tax.

However, the IRS is not an idiot and they know that there is a slight loophole in the S-Corporation tax election. Therefore, they require you to take what's called a "reasonable salary", which we'll discuss more in a bit.

Let's first look at an example:

Let's say your LLC is a web design business and has a gross income of $120,000 and your expenses are $20,000. Your net income is therefore $100,000.

You and your accountant decide on a reasonable salary of $60,000 per year, which is average for your industry.

You'll end up paying 15.3% self-employment tax on the $60,000 wage, but the remaining $40,000 in distributions (profit) will not be subject to the 15.3% self-employment tax, therefore you'll save $6,120 in taxes.

Now it's not pure tax savings though. Your administrative costs will offset your savings a little, however, for most businesses with a net income of $75,000 to $100,000 per year (or more), the tax savings are usually still greater than the expenses.

Here are your S-Corp administrative responsibilities:

? You have to nm payroll, ? You have to file quarterly payroll returns (federal and state), ? You have to keep accurate books and a balance sheet, and ? You should hire an accountant to file your corporate tax return (Form 1120S, K-ls for shareholders/

owners, and any additional Schedules)

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LLC Taxed as an S-Corp (Form 2553)

IN PARTNERSHIP WITH LEBEAU & ASSOCIATES

Also, depending on the number of employees you have and in what state you're located, you'll also need to take care of federal unemployment insurance, state unemployment insurance, and workers' compensation insurance.

The administrative costs will vary depending on your business and situation, but as a per-year ballpark, payroll can cost $400 to $600, accounting and bookkeeping also at $400 to $600, and tax prep services paid to your accountant can range from $700 to $1,000.

So overall, your administrative costs may be $1,500 to $2,500 (maybe up to $3,000 in some cases). So you spend $3,000 to save $6,120, for a net tax savings of $3,120.

And granted, the higher your company's profits, the more you can save on self-employment tax.

S-Corporation owner-employee & reasonable salary At this point, you may be thinking, "How do I determine a reasonable salary?"

Here are some factors to consider: ? Experience, training, and certifications ? Duties and responsibilities ? History of prior dividend payouts ? The time and effort you provide to the business ? How much you pay regular employees (if applicable) ? What similar business pay employees for similar services ? If there is use of a formula to determine compensation

As a general rule of thumb, it's good to document how your time is spent in the business, and what the appropriate salary is for each of those activities.

For example, let's say you spend 50% of your time on web design, 25% on marketing, and 25% on customer service. And let's also assume you work a 40-hour workweek and work 50 weeks per year (taking a 2-week vacation).

In our example: ? a web designer's average salary came to $65,000 per year, ? a marketing coordinator's salary came to $46,500 per year, and ? a customer service representative's salary came to $32,600 per year

We then took 50% of the web design salary ($32,500), 25% of the marketing coordinator salary ($11,625), and 25% of the customer service representative salary ($8,150) to arrive at a total salary of $52,275.

Of course this is just an example. There are many factors to consider when determining your SCorporation salary. We recommend speaking with your accountant, and however you determine your salary, make sure you document it in case of an audit in the future. It's also advisable to draft and sign a compensation agreement between you and your S-Corporation.

General rules ? Some tax advisors recommend keeping your distributions no more than 3x your salary. For example, if your net income is $150,000, your salary is $50,000 and your distributions are $100,000.

? More conservative tax advisors say to keep your distributions at 50% of your net income. For example, if your net income is $150,000, your salary is $75,000 and your distributions are $75,000.

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LLC Taxed as an S-Corp (Form 2553)

IN PARTNERSHIP WITH LEBEAU & ASSOCIATES

The IRS can reclassify distributions: On another note regarding S-Corporation reasonable compensation, it's important to remember that if at some point, the IRS determines that your salary is not reasonable, they can reclassify the distributions you already took, tax them, and add on penalties, interest, and fines.

This can all be very complex but in general if your gross income falls between $75,000 and $100,000 you could benefit from electing s-corp status for your LLC. There are various requirements that need to be followed to avoid being audited or questioned by the IRS. If you feel you would benefit from electing s-corp status reach out to a tax professional.

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