Is it better to tax LLC as an S Corp?
If you form an LLC without electing S Corp taxation, you stand to pay more in taxes, because you'll be taxed as a sole proprietorship by default. Electing S Corp taxation for your LLC could save you a lot of money in taxes each year.
As the owner of an SMLLC classified as an S corporation you are not considered a self-employed individual and are not subject to federal self-employment tax. Instead, you are considered to be an employee, and—the key point—you can take some, but not necessarily all, available profits from your company as a salary.
Self-employment tax savings: A popular reason for becoming an S corp is the savings you can realize on self-employment tax. S corps pay the owner(s) a salary and only pay payroll taxes on that amount. Any other distributions aren't typically subject to self-employment taxes.
Disregarded entities are the simplest tax classification with straightforward tax reporting. Your LLC is not taxed or required to file a tax return. Instead, the business profits and losses pass to you as the sole owner to be reported on your personal income tax return.
Stock ownership restrictions.
An S corporation can have only one class of stock, although it can have both voting and non-voting shares. Therefore, there can't be different classes of investors who are entitled to different dividends or distribution rights. Also, there cannot be more than 100 shareholders.
The S corporation is the only business tax status that lets you save on Social Security and Medicare taxes while avoiding double taxation. An LLC taxed as an S corp offers the benefits of a corporation while also providing flexibility on income treatment.
LLC owners must pay self-employment taxes on all profits, which can be higher than the taxes paid by S corp shareholders. In some states, LLCs have a limited lifespan and may need to be dissolved after a certain period of time or after a specific event, such as the death of an owner.
Examples of S Corp tax savings
Likewise, the more profit your business earns, the more you'll save. You need to earn at least $40,000 in profit for an S Corp to make sense, though. Otherwise, the costs of forming and running it exceeds the benefits of an S Corp.
Both structures offer pass-through taxation, which prevents double taxation faced by a C corp. However, S corp can provide a tax benefit by allowing owners to pay themselves a salary, while LLC owners are subject to self-employment taxes on their entire income.
LLC vs S Corp in California
In other words, if you convert an LLC into an S corp, you're maintaining the same basic entity structure (albeit with some modifications) but asking the IRS to tax your business as a Subchapter S Corporation rather than an LLC.
What type of LLC pays the least taxes?
Typically, an LLC taxed as a sole proprietorship pays more taxes and S Corp tax status means paying less in taxes. By default, an LLC pays taxes as a sole proprietorship, which includes self-employment tax on your total profits.
- Self-Employment Tax Deduction. Minimizing your tax liability through the self-employment tax deduction is one of the most significant ways to reduce taxable income for LLC owners. ...
- Legal and Professional Fees. ...
- Automobile Expenses. ...
- Bank Fees and Interest. ...
- Home Office. ...
- Office Supplies. ...
- Travel Expenses.
The 60/40 rule is a simple approach that helps S corporation owners determine a reasonable salary for themselves. Using this formula, they divide their business income into two parts, with 60% designated as salary and 40% paid as shareholder distributions.
Under the default LLC taxation, you'll pay self-employment taxes on your full $100,000 of profit. But if your business is taxed as an S-corp, you'll only pay payroll taxes on your reasonable salary of $70,000. The other $30,000 will still be subject to income tax, but not Medicare or Social Security taxes.
S-Corp distributions
You'll still be liable for self-employment taxes on the salary portion of your income, but you'll just pay ordinary income tax on the distribution portion. Depending on how you divide your income, you could save a substantial amount of self-employment taxes just by converting to an S-corporation.
You may or may not have heard of the S Corp Salary 60/40 rule. The guideline refers to setting reasonable compensation between 60% and 40% of the business's net profits. This guideline is not set by the IRS. It should not be relied on as the only factor when setting reasonable compensation.
LLCs also provide a lot of freedom in management as there is no requirement to have a board of directors, annual meetings, or maintain strict record books.
All California LLCs or corporations that choose S Corp taxation must pay a 1.5% state franchise tax on their net income. This is paid by the business itself, not the LLC members or corporate shareholders. Also, all LLCs and S Corps must pay a minimum franchise tax of $800 annually, except for the first year.
As a certain type of small business corporation, an S corp offers many advantages in the form of tax benefits, liability protection, increased prestige, and generous retirement contribution limits. The main disadvantages are a fairly involved setup process and requirements that must be carefully followed.
All corporations are required to file a corporate tax return, even if they do not have any income. If an LLC has elected to be treated as a corporation for tax purposes, it must file a federal income tax return even if the LLC did not engage in any business during the year.
How can a LLC avoid paying too much taxes?
As an LLC, you can elect to be taxed as an S corporation. If you choose this option, you will not pay self-employment tax.
- Itemize business deductions. ...
- Take the home office deduction. ...
- Pay yourself a “reasonable” salary. ...
- Hire your children. ...
- Deduct state taxes (if possible) ...
- Use tax credits (if eligible) ...
- Take the Qualified Business Income (QBI) deduction.
As an S Corporation shareholder who is also actively working in the business, you must pay yourself a reasonable salary for the services you provide. This is to ensure that you're paying payroll taxes appropriately and not avoiding Social Security and Medicare taxes (also known as FICA taxes).
Personally, I think if your business is making more than $60,000 in profit every year, then you should look into forming an S corp. Keep in mind that we're talking about taxable income, not gross revenue. Your gross revenue is all the money you make from your products and services.
In general, you'll want to consider electing S-corp tax status for your LLC if your business is generating sufficient profits to pay a reasonable salary to the members and annual distributions.
