When to switch from an LLC to an S-Corp Election
Starting a business can be extremely confusing with so many different options and choices spread out in front of you. Your head is probably spinning and you may have gone down a rabbit hole of the what-if scenarios of what could possibly go wrong. We get it!
When it comes to the structure of your business, it can be hard to know when you’ve outgrown either the sole-proprietor or LLC classification and need to upgrade the framework of your company. Making an S-Corp election is a great next step for many growing businesses and we’re here to break it down for you!
What is an LLC?
Most small businesses choose to be organized as limited liability companies because, compared to corporations, LLCs have more management flexibility and fewer legal requirements. This is helpful for new or smaller business owners who want to avoid unnecessary headaches.
What is an S-Corp Election?
As an LLC you have the option to elect S-Corp status with the IRS, allowing you to maintain the simplicity of an LLC and gain access to some of the benefits of having corporate status. By making this election your company is still an LLC but allows you to be taxed as an S-Corp. The primary advantage to this election being a savings in employment taxes, allowing an owner to be considered an employee of the company, and protecting the owner(s) from being taxed twice.
Why Would You Switch?
One of the main reasons someone would choose S corp for tax purposes is to save money self-employment taxes.
When an LLC is taxed as an S corp, owners are able to be considered company employees instead of being taxed as self-employed with requirements to pay Social Security and Medicare taxes on business profits. Whereas in an S-corp, since owners can be considered employees, they are required to pay themselves a living salary and only pay Social Security and medicare taxes. A definite win for the owner!
Owners of an S-Corp may also have the option to put more money in tax-deferred retirement accounts than they would have otherwise.
Downsides to an S Corp?
While the process of S-Corp Election is rather simple, S-Corp status does require substantial paperwork and additional expenses. This is especially true if you don't already have other employees.
When Should You Switch?
An LLC would generally switch around $40,000 to $60,000 net income. However, the break-even point where self-employment tax exceeds that faced by an S-corp will be different for each business.
IRS Deadline & Requirements
One of the worst feelings you can have when running a business, is missing major deadlines that will have an impact on your business.
For the IRS, there are clear parameters and deadlines throughout the year that businesses need to meet in order to avoid late fees and other repercussions for missing deadlines.
One of those deadlines would be filing the IRS Form 2553 by March 15th of the year you plan to make the switch to an S-Corp from an LLC .
Don’t freak out too much if you have already missed the deadline to switch over to a S-Corp. We can help lead you in the right direction if a mistake was made and work with you through this process.
In order to file late, the IRS does have requirements. One of those being that all requirements were met on the date the entity wishes to be considered for S Corp election.
There are various and reasonable causes why someone would need to file late. Some examples would be--the owner(s) did not know that the election needed to be made, the owner(s) did not know that the election needed to be made in advance of taxes being filed, or the owner(s) or accountant neglected to do so.
An LLC is eligible to elect for S corp. taxation if it meets a few requirements for S corp. ownership and organization. Such as:
- Being a U.S. based business
- Have 100 or less shareholders (owners). Shareholders cannot be corporations, partnerships or non-resident aliens. They must be individuals, trusts and estates.
- Only have one class of stock
Without meeting these requirements, an LLC will not be able to switch to an S corp.
Bear Financial would love to help walk you through these detailed tax questions, helping you avoid mistakes and further confusion.