There are always two things that solopreneurs are in short supply of… time and money for taxes. Some entrepreneurs pay their taxes quarterly and avoid this need to save up a giant chunk of money for year-end tax bills. Others go the once a year route and fail to save or find the giant tax savings sum a spending temptation. If you run your own business, you’ve likely dipped into your tax savings here and there. Sometimes it’s all too easy to borrow your tax funds to cover personal expenses, an emergency purchase or other needs for quick business funding. Now that you’ve likely filed your taxes (or applied for an extension), you’re feeling the hurt of this year’s tax bill. But, there’s a way for you to save yourself a couple bucks on tax payments in the future.
First, you’re going to want to file your business as an LLC. Most small businesses file as an LLC for many reasons. Not only are your personal assets protected if your company acquires debt, but it also has less guidelines and stipulations than other business structures. In addition, one of the best advantages of filing as an LLC is that you can choose how it is treated as a taxable entity. By default, multi-owner LLCs are automatically taxed as a partnership while LLCs with a single owner are taxed like sole proprietorships. However, LLCs have the option to choose whether to be taxed as a C Corporation or S Corporation.
How LLCs are Taxed
If you have an LLC and are the sole proprietor (a single owner or “member” of the LLC), the LLC itself doesn’t have to file a tax return with the IRS nor does it have to pay taxes. Instead, it is a “pass-through” entity and the profits or losses of the LLC are reported on a Schedule C form and submitted with your personal 1040 tax return.
If there are multiple owners, then the LLC is treated as a partnership. As with a single owner, the LLC doesn’t pay taxes since the LLC owners each pay their share on their personal income tax returns (with a Schedule E form attached). This is called the “distributive share” when each of the LLC’s members share the profits and losses as determined by the LLC operating agreement.
How LLCs are Taxed as an S Corp
If an LLC is filed as an S Corp, the initial process is similar to what was mentioned above; the LLC is still a pass-through entity and income and losses are reported on the owners’ personal tax return. However, there are a few minor differences when filing:
An S Corporation files an information return (Form 1120S) in which they will report the corporation’s income, deductions, profits, losses, and tax credits for the appropriate year. Additionally, Schedule K-1 of Form 1120S is used to report each shareholder’s agreed upon share of net income or loss from an S-Corporation. Shareholders must also file a Schedule E form with their personal tax returns (Form 1040) to report their share of corporation’s income or losses.
Why Should I File My LLC as an S Corp?
The owner of an LLC is taxed as the business owner and not necessarily an employee. However, the owner of an S Corp that performs active services for the corporation will be its employee AND owner for tax purposes.
Typically the employee/owner must report any S Corporation’s earnings on his or her personal income tax return and contribute to his or her share of Social Security and Medicare taxes on the “reasonable” salary that they earn. Businesses with multiple employees are also required to withhold federal income and employment taxes from the employees’ pay check while also paying state and federal unemployment taxes, Social Security and Medicare taxes on behalf of the employees.
Now here’s where the “secret” comes in to saving you money: Being classified as an S Corporation employee/owner allows you to save money by paying less in taxes. Since the profits are being “passed through” to your personal tax return as whole or part owner of the company, you don’t have to pay the traditional Social Security and Medicare taxes as a traditional employee. If you are taxed as a standard LLC (not taxed as an S Corp), you have to pay employment tax on your entire salary. As an S Corp, you will only need to pay federal income tax on the monies you receive. For example, if you take $70,000 out of the business, as a standard LLC you would pay $10,710 in employment tax. Filing as an S Corp, if you took out $45,000 as salary and $25,000 as distributions, you would only pay $6,885 in employment tax which is a savings of $3,825.
To understand how much money you could save as a sole-owner of an LLC filing as an S Corp, you can check out this S Corporation Tax Calculator.
How Do I File My LLC as an S Corp?
To file your LLC as an S Corp for future tax returns, you simple need to file IRS Form 2553 with the IRS. However, there are some requirements that you must abide by:
- Your S Corp must have fewer than 100 owners.
- It must be a domestic company organized under the laws of one of the 50 states and you cannot have nonresident alien members.
- None of the members can be other business entities except nonprofits classified under sections 401(a) or 501(c)(3) of the tax code.
Also, there are certain dates you must file this Form 2553 by. According to the IRS it must be filed:
No more than two months and 15 days after the beginning of the tax year the election is to take effect, or At any time during the tax year preceding the tax year it is to take effect.
That means, for you to file your 2017 LLC taxes as an S Corp, you needed to file form 2553 by March 15th. However, the IRS does allow you to file form 2553 late and details how to do this in their “Relief for Late Elections” section found in instructions for form 2553.
The conclusion: file that form late, if you can, or put a reminder in your calendar to file it this coming January. Either way, you should have a future of tax savings awaiting you, which is a good feeling even if you’re late to the game.
Dustin Ray leads business development and growth initiatives at Incfile, a national document filing service company specializing in the formation of business entities. Founded in 2004, Incfile had assisted in the formation of more than 100,000 Corporations and LLCs. For only $49 a month + state fees, Incfile can help you easily and quickly form your LLC and start your business today.