Some LLCs and corporations (if they meet the IRS’s eligibility requirements) may choose to be taxed as an S Corporation. But what does that mean exactly?
With 2019 just beginning, now is a perfect time to consider whether an S Corp election might benefit your business. Moreover, the deadline for choosing tax treatment as an S Corporation is fast approaching (March 15) if your business tax year aligns with the calendar year and you want to be treated as an S Corp in 2019.
Whether an S Corp election will benefit your business depends on various factors. To fully understand how it would impact you, talk with an attorney and tax adviser for expert guidance suited to your specific situation.
Potential S Corp benefits for LLCs
Many LLC owners have found they can decrease their tax liability by filing for the S Corp election. Normally, all business income and losses flow through to LLC owners’ personal income tax returns. As a result, owners pay income tax on all of their company’s profits—and that income is also subject to self-employment taxes (Medicare and Social Security). However, with S Corp tax treatment, owners only pay self-employment taxes on their personal wages and salaries that the business paid them.
For an LLC to make the S Corporation election, it must first file IRS Form 8832 (Entity Classification Election) to be classified as a corporation for federal tax purposes. Then it must submit IRS Form 2553 (Election by a Small Business Corporation) to elect S Corp status.
Potential S Corp benefits for C Corporations
Normally, C Corps experience something known as “double taxation.” The corporation pays federal income tax on all of its income (after allowed deductions, credits, etc.). Some of that income gets taxed again at the individual taxpayer level when it’s given as profit distributions to shareholders.
Choosing the S Corp election (by filing IRS Form 2553) allows corporations to avoid that double taxation. When treated as an S Corporation, essentially all business income and losses flow through to shareholders’ personal tax returns. The corporation does not pay taxes on it (with the exception of certain built-in gains and passive income at the entity level). As a result, the business’s income is taxed only at the applicable tax rates for individuals, not at the corporate income tax rate.
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The effect of tax code changes
I’d be remiss if I didn’t mention that the recent tax changes may influence whether choosing S Corp election will be a win for a business.
With the new lower corporate tax rate of 21%, some C Corps might pay less in taxes by sticking with the traditional tax treatment (even with double taxation factored in) than undergoing S Corporation pass-through tax treatment. Why? Shareholders’ individual tax rates (depending on their amount of taxable income) might be higher than the corporate tax rate.