The deadline to elect S Corporation tax treatment for your LLC will depend on whether your LLC is new or is in its second (or later) tax year. For a new LLC, you will have to file an S-Corp election within two months and 15 days (75 days total) of the date of formation for the election to take effect in the first tax year.
Meanwhile, for an existing business and to make an election in subsequent years, you are allowed to file the election at any point from the first day of your preceding tax year up to two months and 15 days after the start of the applicable tax year.
An S Corporation is not a separate type of business entity; rather it is a special tax election an LLC requests through the IRS. To elect for S Corp status, an LLC will have to file Form 2553 (Election by a Small Business Corporation).
Note that an S Corporation’s corporate income, losses, deductions, and credits flow through to its shareholders (owners). By default, an LLC is a pass-through tax entity. It simply entails that all an LLC’s profits flow through to its owners’ personal tax returns.
By electing S Corporation tax treatment, have it in mind that the income paid to LLC members through payroll is still subject to self-employment taxes, but any profits paid as distributions are not subject to Social Security and Medicare taxes.
While the tax aspects can be quite different, an LLC with S Corporation status comes with the same business compliance requirements as it would with default tax treatment. Howbeit, it does not become subject to the rigid corporate compliance formalities of C Corporations.
For federal tax purposes, you can more or less make an election for the LLC to be taxed as an S-Corporation. All you need to do is download and complete a form and send it to the IRS. Immediately the LLC is classified for federal tax purposes as a Corporation, it can file Form 2553 to be taxed as an S-Corporation.
However, just as was noted above, you will need to file to elect your LLC as an S-Corp by March 15 for it to apply for the following year, or within 75 days of opening the LLC to be applicable for the year of opening.
Why You Should Consider Electing S Corp for Your LLC
In the United States, you need to understand that your self-employment taxes also increase as your income from the LLC grows. It simply means that when you earn more, you also pay more tax, but your capacity to invest in your retirement accounts does not change. Note that electing S Corp status for your LLC provides you with this leverage and much more.
Self-Employment Tax Savings
This is one of the most popular advantages of electing to tax your LLC as an S Corp. Just as it was noted above, with an LLC, the income and profits flow through to the owners’ personal tax returns, and they will also have to pay 15.3% self-employment tax.
S-Corp election allows a business owner to split profits into “shareholder wages” (subject to 15.3% self-employment taxes) and “distributive share” (NOT subject to 15.3% self-employment taxes). Active owners in an S-Corp must pay themselves a reasonable salary, but enjoy a 15.3% savings on the rest of their retained profits.
Tax-Preferred Retirement Savings
This is another reason you should consider electing an S Corp status for your LLC. Note that it ensures that you can contribute more to your retirement accounts especially since with an S-Corp you can set up a Solo 401k. Most often, only those with an income of less than $120,000 are permitted to contribute up to $5,500 to a Roth IRA/401k.
However, with a Solo 401k, you are allowed to contribute up to $18,000 to a Roth Solo 401k, as long as your salary is not less than $18,000. Have in mind that you are not allowed to contribute more than your salary.
Aside from the Roth contribution, also note that you are allowed to contribute up to another $36,000 to a traditional Solo 401k; although this will also depend on the salary, to a total contribution of $54,000. However, with a properly arranged benefit profit-sharing plan, older entrepreneurs can limit their tax liability more while contributing more and more to their retirement savings.
The Perfect Time to Elect S Corp Status for Your LLC
According to tax experts, it is super ideal to elect to tax your LLC as an S-Corp when your self-employment tax goes above the tax burden faced by the business. Agreeably, with a net income of around $40,000, you should consider electing an S-Corp status for your LLC.
Although this will vary from one business to another, the breakeven point could even be as low as $25,000 net income. However, the details depend on a wide range of factors, including:
Note that active owners in an S-Corp are expected to pay themselves a reasonable salary from the profits. What is considered a reasonable salary will most often depend on the net income of your company and industry; therefore, it can be quite unrealistic to quote a target dollar figure.
While most experts will ask that salary be two-thirds of net income, you must take this with a grain of salt; especially since salary numbers can vary and be subjective depending on industry standards and should be maintainable.
Foreign Earned Income Exclusion (FEIE)
For LLC owners who reside abroad, the Foreign Earned Income Exclusion can minimize income tax but not self-employment tax. Meanwhile, with an S-Corporation, the owner can take a salary from the profits and still apply for the Foreign Earned Income Exclusion to minimize income tax. If the owner qualifies for the Foreign Earned Income Exclusion, note that he or she can exclude up to $107,600 of the salary from income tax.
In the United States, you need to understand that some states tax at the S-Corp level and the individual shareholder level. Have it in mind that States such as California and New York tend to tax the S-Corp on behalf of the individual especially if the individual does not have NY residence. Owing to that, if you are incorporated in one of those states, your tax savings for electing for your LLC to be taxed as an S Corp diminishes.
If you own a limited liability corporation that qualifies to be taxed as an S Corporation, your business is allowed to file the election for S-Corp treatment within a particular time frame. Just as was noted above, this time frame will most often depend on whether your LLC is new or not.
However, sole proprietorships and partnerships will first have to form an LLC or incorporate their business before they can qualify to elect S Corporation tax treatment. Business owners are expected to file entity formation paperwork with the state and complete other requirements to legally form their company before electing S Corporation status.