Sub Chapter S Election — Form 2553 To Save Your Business Money On Taxes

If your small busi­ness is or per­haps more impor­tant­ly will be net­ting you over $50,000 this tax year and you’re oper­at­ing your LLC as a dis­re­gard­ed enti­ty, you may be pay­ing too much in tax­es.

One poten­tial strat­e­gy on reduc­ing your tax lia­bil­i­ty and keep­ing more of your hard earned mon­ey in your pock­et is being smart about how your busi­ness oper­ates. This includes for many, tak­ing what’s known as a S cor­po­ra­tion elec­tion.

I have pro­vid­ed a link at the bot­tom for the IRS form 2553.

Tak­ing a S cor­po­rate elec­tion does­n’t mean chang­ing your sole pro­pri­etor­ship or LLC busi­ness into a cor­po­ra­tion, tak­ing the elec­tion means the TAX TREATMENT of your busi­ness, includ­ing LLCs is an S Cor­po­ra­tion.

For those with­out an LLC or cor­po­rate enti­ty, this means either form­ing an LLC or cor­po­ra­tion (for most small busi­ness­es, an LLC is the supe­ri­or choice and feel free to reach out to dis­cuss why) to avail the tax advan­tages of being taxed as an S cor­po­ra­tion. Keep this in mind, because gen­er­al­ly, for most small busi­ness­es, espe­cial­ly those with­out investors oth­er than the fam­i­ly that will own it, an LLC is FAR supe­ri­or as a busi­ness enti­ty solu­tion than a cor­po­ra­tion.

For almost all small busi­ness­es oper­at­ing as Lim­it­ed Lia­bil­i­ty Com­pa­nies (LLCs), the ques­tion of tax opti­miza­tion often aris­es, espe­cial­ly dur­ing tax sea­son.

While LLCs offer the appeal­ing com­bi­na­tion of lim­it­ed lia­bil­i­ty pro­tec­tion and pass-through tax­a­tion, there exists a dis­tinct enti­ty called an “S cor­po­ra­tion” that presents poten­tial­ly sig­nif­i­cant tax advan­tages under cer­tain cir­cum­stances.

How­ev­er, nav­i­gat­ing the intri­ca­cies of elect­ing S cor­po­ra­tion sta­tus requires care­ful con­sid­er­a­tion and under­stand­ing.

Let’s exam­ine the basics. Includ­ing an out­line of the many the ben­e­fits, draw­backs, and cru­cial steps involved in the process. Again, it’s impor­tant to note and high­light that we’re dis­cussing the tax treat­ment avail­able to most LLCs if it makes finan­cial sense.

Under­stand­ing the Play­ing Field: LLCs vs. S Cor­po­ra­tions

LLCs and LLC’s tak­ing the S cor­po­rate elec­tion share some key fea­tures, includ­ing pass-through tax­a­tion, where busi­ness income and loss­es flow direct­ly to the own­ers’ per­son­al tax returns. How­ev­er, sig­nif­i­cant dif­fer­ences exist in terms of tax treat­ment, own­er­ship struc­ture, and for­mal­i­ties.

LLC:

Tax­a­tion: LLCs are taxed as sole pro­pri­etor­ships or part­ner­ships, depend­ing on the num­ber of own­ers.

Own­er­ship: LLCs have no restric­tions on the num­ber or type of own­ers, includ­ing non-res­i­dent aliens and cer­tain trusts.

For­mal­i­ties: LLCs have less strin­gent admin­is­tra­tive require­ments than cor­po­ra­tions, and when an LLC takes a S cor­po­rate elec­tion the for­mal­i­ties remain the same in most aspects.

S Cor­po­ra­tion Elec­tion:

Tax­a­tion: S cor­po­ra­tions also avoid dou­ble tax­a­tion by elect­ing to be taxed sim­i­lar­ly to part­ner­ships. Share­hold­ers pay tax­es only on their indi­vid­ual tax returns based on their share of cor­po­rate income and loss­es.

Own­er­ship: S cor­po­ra­tions are lim­it­ed to 100 share­hold­ers who must be US cit­i­zens or res­i­dent aliens. Only one class of stock is allowed. For almost all small busi­ness­es, this isn’t a fac­tor at all.

Weigh­ing the Pros and Cons: Is an S Corp Elec­tion Right for You?

The deci­sion to elect S cor­po­ra­tion sta­tus should be based on a com­pre­hen­sive analy­sis of your spe­cif­ic busi­ness sit­u­a­tion and finan­cial goals. Here’s a break­down of the key advan­tages and dis­ad­van­tages:

In Favor:

Avoid­ance of dou­ble tax­a­tion: This can be a sig­nif­i­cant ben­e­fit for busi­ness­es with high prof­its and active own­ers who wish to pay tax­es at low­er indi­vid­ual rates.

Poten­tial­ly low­er pay­roll tax­es: S cor­po­ra­tion own­ers clas­si­fy them­selves as employ­ees and receive a salary, akin to a LLC, how­ev­er, by tak­ing the S corp elec­tion, the own­er may be able to shift some income from earned income sub­ject to Social Secu­ri­ty and Medicare tax­es to “invest­ment income,” there­by reduc­ing Social Secu­ri­ty and Medicare tax­es on a por­tion of their income.

For most busi­ness own­ers, this is the most sig­nif­i­cant and mean­ing­ful moti­va­tion to make the change.

Attrac­tive to investors: S cor­po­ra­tion sta­tus can be appeal­ing to poten­tial investors due to the pass-through tax­a­tion fea­ture.

Low­er Audit Risk: This is hard to quan­ti­fy for any giv­en busi­ness, and real­ly should­n’t be a heav­i­ly weight­ed fac­tor, how­ev­er, I don’t know any­one who wants to be audit­ed by the gov­ern­ment even when the books are per­fect. At a min­i­mum, it’s an uncom­fort­able dis­trac­tion for the busi­ness own­er.

Against:

Own­er­ship restric­tions: The 100-share­hold­er lim­it and citizenship/residency require­ments can be lim­it­ing for some busi­ness­es. Again, for most, this does­n’t mat­ter.

Increased admin­is­tra­tive bur­den: S cor­po­ra­tions require more for­mal record­keep­ing and meet­ings, lead­ing to addi­tion­al costs and com­pli­ance oblig­a­tions. If a LLC enti­ty busi­ness takes the S cor­po­ra­tion elec­tion, actu­al pay­roll must be per­formed (if the busi­ness already has employ­ees, this is a min­i­mal cost fac­tor) and the busi­ness will file a sep­a­rate tax return sim­i­lar to a C cor­po­ra­tion called a 1120s tax return, albeit the income con­tin­ues to pass-through to the owner(s).

Poten­tial for pay­roll tax issues: The clas­si­fi­ca­tion of own­ers as employ­ees can trig­ger com­plex pay­roll tax rules and poten­tial IRS scruti­ny.

Navigating the Maze: Taking an S Corporation Election for Your Small Business LLC

For many small busi­ness­es oper­at­ing as Lim­it­ed Lia­bil­i­ty Com­pa­nies (LLCs), the ques­tion of tax opti­miza­tion often aris­es.

While LLCs offer the appeal­ing com­bi­na­tion of lim­it­ed lia­bil­i­ty pro­tec­tion and pass-through tax­a­tion, there exists a dis­tinct enti­ty called an S cor­po­ra­tion that presents poten­tial­ly sig­nif­i­cant tax advan­tages under cer­tain cir­cum­stances.

How­ev­er, nav­i­gat­ing the intri­ca­cies of elect­ing S cor­po­ra­tion sta­tus requires care­ful con­sid­er­a­tion and under­stand­ing. This arti­cle delves into the essen­tial aspects of mak­ing an S cor­po­ra­tion elec­tion for your small busi­ness LLC, out­lin­ing the ben­e­fits, draw­backs, and cru­cial steps involved in the process.

Under­stand­ing the Play­ing Field: LLCs vs. S Cor­po­ra­tions

LLCs and S cor­po­ra­tions share some key fea­tures, includ­ing pass-through tax­a­tion, where busi­ness income and loss­es flow direct­ly to the own­ers’ per­son­al tax returns. How­ev­er, sig­nif­i­cant dif­fer­ences exist in terms of tax treat­ment, own­er­ship struc­ture, and for­mal­i­ties.

LLC:

Tax­a­tion: LLCs are taxed as sole pro­pri­etor­ships or part­ner­ships, depend­ing on the num­ber of own­ers.

Own­er­ship: LLCs have no restric­tions on the num­ber or type of own­ers, includ­ing non-res­i­dent aliens and cer­tain trusts.

For­mal­i­ties: LLCs have less strin­gent admin­is­tra­tive require­ments than cor­po­ra­tions.

S Cor­po­ra­tion:

Tax­a­tion: S cor­po­ra­tions avoid dou­ble tax­a­tion by elect­ing to be taxed sim­i­lar­ly to part­ner­ships. Share­hold­ers pay tax­es only on their indi­vid­ual tax returns based on their share of cor­po­rate income and loss­es.

Own­er­ship: S cor­po­ra­tions are lim­it­ed to 100 share­hold­ers who must be US cit­i­zens or res­i­dent aliens. Only one class of stock is allowed.

For­mal­i­ties: S cor­po­ra­tions have stricter admin­is­tra­tive require­ments, includ­ing annu­al meet­ings, board of direc­tors, and for­mal record­keep­ing.

Weigh­ing the Pros and Cons: Is an S Corp Elec­tion Right for You?

The deci­sion to elect S cor­po­ra­tion sta­tus should be based on a com­pre­hen­sive analy­sis of your spe­cif­ic busi­ness sit­u­a­tion and finan­cial goals. Here’s a break­down of the key advan­tages and dis­ad­van­tages:

Advan­tages:

Avoid­ance of dou­ble tax­a­tion: This can be a sig­nif­i­cant ben­e­fit for busi­ness­es with high prof­its and active own­ers who wish to pay tax­es at low­er indi­vid­ual rates.

Poten­tial­ly low­er pay­roll tax­es: S cor­po­ra­tion own­ers can clas­si­fy them­selves as employ­ees and receive a salary, there­by reduc­ing Social Secu­ri­ty and Medicare tax­es on a por­tion of their income.

Attrac­tive to investors: S cor­po­ra­tion sta­tus can be appeal­ing to poten­tial investors due to the pass-through tax­a­tion fea­ture.

Dis­ad­van­tages:

Own­er­ship restric­tions: The 100-share­hold­er lim­it and citizenship/residency require­ments can be lim­it­ing for some busi­ness­es.

Increased admin­is­tra­tive bur­den: S cor­po­ra­tions require more for­mal record­keep­ing and meet­ings, lead­ing to addi­tion­al costs and com­pli­ance oblig­a­tions.

Poten­tial for pay­roll tax issues: The clas­si­fi­ca­tion of own­ers as employ­ees can trig­ger com­plex pay­roll tax rules and poten­tial IRS scruti­ny. For most small busi­ness own­ers, this is gen­er­al­ly a non issue. A sim­ple set­up with a pay­roll provider (which we can arrange) takes this bur­den off the busi­ness own­er. A key com­po­nent for the busi­ness own­er though, and this should not be over­looked, is cre­at­ing a “rea­son­able salary” for the busi­ness own­er. The IRS requires busi­ness own­ers to take a rea­son­able salary before dis­tri­b­u­tions. We offer a rea­son­able salary sur­vey for clients that can be used in the case of an audit. You can sim­ply “guess” the amount, and you will like­ly over­pay your­self, caus­ing an increase in the self-employ­ment tax, or under­pay your­self, caus­ing a major prob­lem dur­ing an audit due to under­re­port­ing.

An Account­able Plan: An S Corp will almost cer­tain­ly want to have an account­able plan. This adds cost to the set­up cost in both time and expense, and ongo­ing main­te­nance and account­ing oblig­a­tions. The ben­e­fit though can far out­weigh the added cost and increased com­pli­ance as it poten­tial­ly opens the door for many addi­tion­al and ‘bet­ter’ deduc­tions.

Tak­ing the Plunge: The Elec­tion Process Explained

If, after care­ful con­sid­er­a­tion with your tax pro­fes­sion­al, you decide to pur­sue S cor­po­ra­tion sta­tus, here’s a step-by-step guide to the elec­tion process:

Eli­gi­bil­i­ty Check: Ensure your LLC meets all S cor­po­ra­tion require­ments, includ­ing num­ber and type of own­ers, US citizenship/residency, and sin­gle class of stock.

Share­hold­er Con­sent: Obtain writ­ten con­sent from all exist­ing share­hold­ers agree­ing to the elec­tion. This is some­times skipped acci­den­tal­ly when a hus­band and wife both own the LLC. When there is more than one own­er, includ­ing a spouse, ALL own­ers need to sign and approve.

Form 2553: File IRS Form 2553 and return to the IRS by the due date of your cor­po­rate tax return (includ­ing exten­sions) for the year you wish the elec­tion to be effec­tive. This gen­er­al­ly means March 15th of each year. While there can be rea­sons to jus­ti­fy a late 2553 fil­ing, it’s best if done pri­or to March 15 for pay­roll rea­sons.

State Fil­ings: Depend­ing on your state, you may need to file addi­tion­al forms or noti­fy state author­i­ties of the elec­tion.

Should your busi­ness take the elec­tion? That real­ly depends on a few fac­tors and as stat­ed near the top, gen­er­al­ly, a busi­ness may ben­e­fit if the net earned income is over $50,000, how­ev­er, there’s a large grey area that can be con­sid­ered with income as low as $40,000 a year too. And as you may imag­ine, as the income increas­es from $40,000 towards $50,000 the case becomes stronger.

Elect­ing S Cor­po­ra­tion sta­tus for an LLC can offer mean­ing­ful tax sav­ings and ben­e­fits for small busi­ness own­ers. How­ev­er, it’s essen­tial to approach this deci­sion with a com­pre­hen­sive under­stand­ing of both the advan­tages and the poten­tial com­plex­i­ties involved which means for most a con­ver­sa­tion with a tax advi­sor who can lay out the pros and cons to make sure you’re mak­ing an informed deci­sion.

You can down­load the 2024 IRS Form 2553 HERE