Most businesses start with one owner and one employee and they are usually the same person! Some businesses are even started as a side business while working after hours and on the weekends until they can accommodate a payroll…Sound familiar? Some entrepreneurs go ahead and create an LLC for liability protection when they are first getting started. This blog focuses on Limited Liability Companies changing their entity to be taxed as an S Corporation.
Regardless of how you started, you may be at a point now where you are asking, “Is this still the right entity structure for my business?”
When to make this decision?
January 1st is the best and easiest time to switch your LLC to an S Corporation for tax purposes. The IRS allows you 75 days to file the election. March 15th is the deadline to complete and file Form 8832 with the IRS when you are converting from an LLC to an S Corporation. It goes without saying, but I’m going to say it anyway, everything you mail to the IRS should go stamped Certified Mail with a Certified Return Receipt! 100%
Some rules can be stretched!
The deadline can be extended until the day you file the tax return for the year, via Revenue Procedure 2013-30…that’s right, the deadline isn’t the deadline. Only the IRS makes this stuff up. You have to meet a few criteria, but otherwise, if you miss the March15th deadline, but it can still be done.
Criteria for filing for an S Corporation with your tax return with late election relief:
1. You have to be an eligible entity to elect to be treated as an S Corporation.
2. You have to have intended to be treated as an S Corporation for the entire year.
3. The only reason why you didn’t qualify was that you did not file IRS Form 8832 timely or you filed Form 2553 with the tax return and therefore Form 8832 was deemed to have been filed.
4. You failed to qualify as an S Corporation because the S Corporation election was not timely filed.
5. You filed all the federal tax returns and information returns consistent with being treated as an S Corporation, or the due date hasn’t passed yet so the return is not yet due.
Motivating factors to make the change.
Tax savings…there is a break-even point for the purposes of tax savings…every one’s taxes are different so the tax break-even point for one business owner will be different than for another owner based on their other investments and their income levels. Payroll taxes are a deduction to S Corporations, which reduces your taxable income by the amount paid. Owners of LLCs receive the income pass-through from the business and pay self-employment taxes without the deduction benefit.
Tax-preferred retirement savings…the amount you can save for retirement depends on your wages and/or the type of investment you open. You can contribute up to $22,500 annually to a Roth Solo 401k if you are 50 or less. If you’re over 50 you can contribute up to $30,000.
Add a pre-tax Profit Sharing Contribution to your Solo 401k for an additional $43,500 and you can maximize your 2023 contribution to $66,000 for those under 50 and $73,500 for those over 50.
A defined benefit plan allows older entrepreneurs to invest more money based on actuarial tables, which could be, and I’ve seen it, hundreds of thousands of dollars every year! Find an advisor to help you with these decisions!
Don’t forget the S Corporation Reasonable Compensation requirement. If you elect to have your business taxes as an S Corporation you are REQUIRED to pay yourself a REASONABLE compensation. See my earlier blog on this subject, but that means paying yourself a wage and having Federal Withholding, Social Security, and Medicare taxes are taken out of your check and remitted to the government…don’t forget to check on your state taxes as well!
Is there a downside?
Be prepared to stick with this decision for at least five years. It’s not something you can change to or from without waiting 60 months before you can change it again.
If you have multiple members in your LLC, it’s best to consult an accountant to further discuss the particulars before making a switch. S Corporations have to take distributions that are pro-rata to their ownership percentages. There is no getting around this. Disproportionate distributions will break an S Corporation and cause a whole host of other issues.