If you’re eyeing to change your business structure to minimize tax liability, you probably heard of the perks you can get upon status conversion of a Limited Liability Company into an S-Corporation. For a single-member LLC taxed as S-Corp, what are the pros and cons a corporation may face in the long run? Here’s our team’s take on this topic to avoid unnecessary confusion.
Single Member LLC Taxed as S Corp
What is a Single Member LLC?
Before we proceed any further, let us first define what it means to operate under a Single-Member LLC business entity. As you may already know, most small business owners choose to incorporate as a limited liability company due to its personal asset protection features.
This legal structure prevents creditors from going after assets of LLC owners during legal disputes. As an SMLLC, you are the sole member of the business and elected to disregarded entity federal tax status by default. However, you have the option to switch your LLC into C-corporation or S-corporation status, depending on the tax purposes you prefer.
Now that introduction’s clear, let’s discuss the tax advantages and disadvantages of these business entities so that you can decide which type of election would benefit your LLC the most.
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How are Single Member LLC Taxed?
As a Disregarded Entity
Upon filing a business under SMLLC, your company is automatically considered as a disregarded entity. You’ll be taxed according to the terms of a sole-proprietorship business and be required by the state to file Schedule C or Schedule E for personal tax return.
On top of personal tax returns, SMLLC owners must pay self-employment tax for Social Security and Medicare (FICA tax) on the annual net earnings or business income.
Pros
- No payroll taxes and no need to file a business tax return
- Tax deduction from income reported on personal tax documents
- Business losses could be offset into the current year’s income
- SMLLC owners have high eligibility for QBI deductions
- Other states offer lower corporate tax rate for unincorporated companies
Cons
- Owners liable to pay self-employment taxes from business profits
- Declared business losses increase the chance of IRS audit
- Declared business losses increase the chance of IRS audit
- Owner and business viewed as same entities during an audit
As a C-Corp
Let us move on to another tax classification you can consider for your SMLLC. Like disregarded entities, businesses elected to C-corporations status are also required to pay income tax but following the state’s corporation tax standards.
Although this type of entity is exempted from self-employment tax, the owner of a C-corporation business is annually taxed for the income made by the company through his/her personal tax return. In tax expert terms, this occurrence is often referenced as double taxation.
Pros
- Owner isn’t required to pay self-employment taxes
- Corporation tax profits are lower compared to other entities
- Income tax rate on owner’s dividends are deduced
Cons
- Not highly recommended for small businesses.
- C-corporation election incurs higher administrative costs.
As an S-Corp
When it comes to perks, S-corp owners definitely have the upper hand. Unlike C-corps, a business operating under S-corporation tax status has the option to split profits through distribution. If you’re wary about double taxation, the election of S-corp tax status prevents that occurrence from happening.
On top of that, a single-member LLC taxed as S-corp doesn’t need to pay self-employment taxes and is eligible for possible QBI deductions [1]. The S-corporation tax status also allows the owner to claim a reasonable salary, as per IRS policies.
Pros
- S-corporation election has more tax advantages than other options on the list
- Owner of S-corps is allowed to claim salary with payroll taxes
- Losses of S-corporations are passed through owners
- Prevents the occurrence of double taxations
- Owners can take a 20% deduction on taxes from profit share
Cons
- Owner’s income could incur lower QBI deductions
- Some states don’t acknowledge an S-corporation as an entity
- Must set-up payroll for the owner
Why Choose an S-Corp Status for Your LLC
Although both structures feature convenient pass-through taxation, the key advantage of switching to S-Corporation for your LLC is its exemption on self-employment taxes. With that policy, owners can pay FICA in the amount of a salary, saving money in the long run.
How to be Elected as an S-Corp
To qualify as an S-corporation, you must file Form 2553 – Election by a Small Business Corporation to the IRS. If you want the status of your taxes to take effect within the year, our team’s advice is to submit them by March 15.
Along with the form to elect S-Corporation, make sure to provide personal information, social security number, and a consent statement.
FAQ
Can a single-member LLC be taxed as an S Corp?
Yes, a single-member LLC can be taxed as an S-Corp. Just like how a corporation does an S-corp status election, all you need to do is file IRS Form 2553. As long as you submitted the form within the start of the tax year, the request of your LLC to elect S-corp status will be processed.
Why would an LLC elect to be taxed as an S Corp?
An LLC would elect to be taxed as an S-Corporation for its highly advantageous tax purposes. Compared to other business set-ups, S-Corporations pay Social Security/Medicare (FICA) on employment income and take QBI deductions on business profits. This feature prevents the occurrence of double taxation.
Who pays more taxes LLC or S Corp?
LLC pays more taxes because S-Corporation has an exemption on self-employment taxes. With FICA taxes paid on a salary basis, running an S-corp can save you an adequate amount of money in the long run. On top of that, corporate profits after deduction of salary are considered unearned income.
Conclusion
After making your single-member LLC taxed as S-corp, keep in mind that this structure can only have a single class of shareholders should you decide to add members into your corporate entity. If you’re still confused about which option to go for, we recommend consulting a tax advisor or tax professional before proceeding to switch structures.
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