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LLC Taxed as S Corp: A Step-by-Step Guide

LLC Taxed as S Corp

You may have heard that there are two different types of companies: the LLC and the S Corporation. But what is the difference between the two when it comes to tax?

Tax is a big issue and the wrong type of company could lead to you paying more tax than you intended. Therefore, more people than ever are choosing to be taxed as an S Corporation, rather than an LLC.

So how do you get your LLC taxed as S corp?

Let’s take a look.

Do you need help setting up an LLC as an S corp? Contact me, Sam Mollaei Esq., a business lawyer at sam@mollaeilaw.com.

LLC vs. S Corp Taxes

The simple answer is that an LLC’s tax is paid by the owner on their individual tax return. An S corp pays out a salary to the owner and anything left over is put through your personal tax return.

So, in short, when it comes to LLC vs S Corp tax, you have the chance to take a big chunk out of your tax by filing as an S corp.

Let’s look at an example:

An LLC with a single owner has $100,000 in net profit. That owner pays tax based on that $100,000. It’s that simple.

So, what about an LLC electing s corp status?

You pay yourself a reasonable salary. So, let’s say a single owner pays himself a $30,000 salary out of that $100,000 net profit. He would then only pay tax on that $70,000.

BUT it’s not as simple as that in reality. As a corporation, you will incur other taxes.

And the act of paying yourself a salary means you’ll have to pay employment taxes (although not self-employment taxes). This may or may not be significant depending on the state you live in.

The situation in California will differ hugely from the situation in the well-known corporate hub of Delaware. However, in most cases, you’ll potentially save thousands on your tax bill.

See how huge the difference is with an LLC taxed as S corp?

If you still need help determining the difference between the two to drop me an email at sam@mollaeilaw.com and I will respond promptly.

LLC Taxed as a C Corp

An LLC taxed as C corp has a few tax disadvantages, so don’t consider this option. The big difference is that a C corp falls victim to DOUBLE taxation.

Unlike LLC vs s corp taxes, a C corp is taxed twice. Its members are taxed in the same way as an LLC, but company income is taxed at the corporation tax rate of 38.9% on all its income without any deductions.

So, let’s look at that example from the previous section again.

A C corp brings in $100,000 net profit paid to a single owner. But before that net profit can be paid to the owner it must be taxed at the corporate tax rate of 38.9%.

So, there’s $66,000 leftover to be paid to the owner. AND an LLC taxed as C corp will then see this $66,000 taxed again at the personal tax rate via the owner’s personal tax return.

Sounds bad, right?

That’s why I recommend choosing to be taxed as an S corp in certain circumstances.

If any of this is unclear to you send me an email at sam@mollaeilaw.com for clarification.

LLC Taxed as an S Corp

The LLC taxed as an S Corp will benefit from individual taxation. Think about it like this: you only pay taxes if your company is successful. That means less for Uncle Sam and more for you.

The big difference between an LLC and an S corp is that you only pay if your company is successful. In the first few years of your company, you can ease your tax burden.

And remember that with our examples we’ve assumed a single owner. With multiple owners, your tax bill will be further cut down.

If you would like more details on how having multiple owners cut down your tax bill message me at sam@mollaeilaw.com.

S Corp vs LLC Tax Benefits

The big benefit is that with an S corp you can pay yourself an income and only pay employment taxes on that income. With an LLC, you pay based on profit and loss only.

It’s true that an LLC is simpler to manage tax-wise, but S corp offers tax benefits you wouldn’t otherwise get. Let’s look at LLC vs S corp tax closely:

  • An S Corp allows you to avoid double taxation.
  • You can also avoid the corporate tax rate of 38.9%.
  • An S Corp is a corporate entity; therefore, it allows you to easily hire independent contractors without much scrutiny from the IRS.

It should be said that the tax laws surrounding both the LLC and the S Corp are extremely complex. Email me at sam@mollaeilaw.com for more information when it comes to your personal situation.

Do keep in mind that single owners with less than $75,000 per year may not benefit from the tax advantages of an S corp.

Why is this the case?

Just because you avoid double taxation doesn’t mean you avoid other taxes. By paying yourself a reasonable salary to mitigate the corporate profits you incur employment taxes, along with other expenses.

As a corporation, you also incur other obligations. But, again, this can depend on the state you live in.

Don’t take the decision to convert lightly.

Can an LLC Also Be a Partnership?

Yes, an LLC can also be a partnership. Understand that the whole point of an LLC is to embrace aspects of both a partnership and a corporation.

Take note, state laws differ when it comes to partnerships. Some states will recognize that an LLC with two or more owners is a partnership.

Many states don’t even require you to file any papers when you form a partnership. But you should still update your operating agreement accordingly.

You don’t need to change your company to acquire a partnership.

What Type of Tax Return Does an LLC File?

It depends! It could be Form 1040, Form 1065, Schedule C, E, or F. It could also be Form 1120 or Form 1120S.

That sounds like a confusing answer. And you would be correct because the tax is confusing.

So which form pertains to which type of LLC, according to IRS Publication 3402?

Let’s start with the simplest part of this. In an LLC with one owner you’ll need to file Form 1040 and Schedule C, E, or F; depending on your company circumstances.

With a single-member LLC, that’s part of a corporation, you’ll file Form 1120 or Form 1120s. These are known as the corporation tax returns and come into play when choosing an LLC S Corp tax structure.

That’s the single-member LLCs out of the way. If you have multiple-member LLC things change slightly.

In most states and with most LLCs, you’ll be expected to file a partnership return. As a corporation, you would file Form 1065.

My advice when you finally settle on one type of return?

Use the same return every year to keep things simple and avoid IRS scrutiny.

If you are unsure which type of tax form you need to file send me a message at sam@mollaeilaw.com today!

How Do You File Taxes for an LLC? 

There are different filing requirements for the type of LLC. You need to be aware of the implications of the filing process and whether it’s better to choose to be an LLC deciding S corp status.

There are three types of filing for an LLC. We’re going to take each one of them in turn.

First, we have the partnership filing requirements:

You must prepare annual partnership returns via IRS Form 1065, which is for informational purposes. Every bit of income, any deductions, and any tax credits must be reported by every owner forming part of the partnership.

The LLC itself reports the owner’s share via Schedule K-1 at the end of the year. These same figures should then match up with every owner’s personal income tax returns.

Second, we have corporate filing requirements:

The big difference with an LLC taxed as S corp is that the IRS will treat your company as a separate individual taxpayer. Every business is responsible on its own for reporting its income via Form 1120 annually.

What’s great about filing as a corporation is that the owners aren’t personally responsible for the business failing to pay its tax. Just remember that your tax rate may be higher when filing as certain types of corporations, as the C corp.

Your dividend counts as taxable income via your personal tax form: Form 1040.

Third, we must address the sole proprietorship filing requirements:

A sole proprietorship loses the benefits of LLC vs S corp tax. The IRS ignores the LLC entity entirely. In other words, under this form of filing, you’re personally responsible for paying your taxes and meeting every deadline.

And when filing Form 1040 you also must fill out a Schedule C. Any profits on the Schedule C must be added to Form 1040.

How Do I Change My LLC to an S Corp? 

The conversion process is as simple as filling a form. But it depends on whether you want to file as a corporation or formally change your LLC to an S corp.

To start with, we’re going to assume that you only want to change your LLC’s tax status. All you must do is file the correct form with the IRS to have your LLC taxed as S corp.

For this, you need Form 8832, which is known as an Entity Classification Form. You’ll still be classified as an LLC, but for tax purposes, you’ll be classified as a corporation.

Take note that when you’ve changed your tax status you can’t change it again for 60 months. After you’ve filed the form you’ll need to start using Form 2553 as an S corp.

But what if you want to go further than getting your LLC taxed as an S corp? You can also formally change your company to an S corp.

The process depends on the state. We’re going to assume you live in a state like Delaware, Nevada, or California, where a formal conversion process is permitted.

So how do you go about it?

  1. You need to file with your state a new corporation with the same name, while at the same time canceling your LLC.
  2. Send a formal letter to the IRS notifying them that you’ve changed the structure of your company.
  3. Send Form 2553 electing to be an S Corp.

In states like Arizona, Colorado, and New York there’s no formal conversion process, so it can get complex and you might even need to formally close your company and form a new one.

For this, you should enlist the help of a professional because there are lots of tax and administrative obligations involved. Feel free to email me directly at sam@mollaeilaw.com for assistance.

LLC to S Corp Conversion

It may look easy, but you do need to beware of various state and federal tax rules. Don’t attempt to get it done in a single afternoon.

So, what would we recommend?

We believe that you need to spend the time necessary to make the conversion. Decide whether it’s really the best option for you.

For example, an independent contractor who earns less than $75,000 per year likely isn’t going to realize the tax benefits of an S corp. Sometimes it’s better to stick to being an LLC.

Only you can make that decision, though.

But overall the conversion process is relatively simple.

Conclusion

The tax benefits of an S corp can let you keep more of your money.

But you need to time your conversion correctly. If you want to keep more of your profits for building your business then an S corp is perfect.

If your profits aren’t significant enough (usually around the $75,000 mark) then you’re not going to see the benefits. And this applies whether you’re a single owner or whether you’ve formed a partnership.

So, what should you do now?

Examine how much you’re paying in tax and then imagine you’re an S corp. Apply the rules of an S corp to last year’s filing and see what you could have saved.

You could find that there’s no real difference at all.

Talk to a lawyer and talk to your accountant. Get some expert advice that pertains to your company’s situation.

Are you going to file as an S corp?

If you still need help to decide if filing as an S corp is right for you, email me at sam@mollaeilaw.com 

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