S Corp Tax Elections

The reason an LLC would want to take advantage of Subchapter S (and be taxed as a S Corp) is to minimize self-employment taxes (aka payroll taxes).

The self-employment tax rate is currently 15.3%. This rate consists of two parts: 12.4% for social security and 2.9% for Medicare. The owners of an LLC pay self-employment taxes (and income taxes) on the LLC's profits.

If you are (1) an owner of an LLC AND (2) an employee receiving W2 wages, you only pay self-employment taxes on your salary, if reasonable (not the LLC's profits).

For example, if a single-member LLC's profit for 2018 is $100,000, the owner will pay self-employment tax of $15,300 (15.3% of $100,000).  If however, the owner pays himself a salary of $60,000, he will pay self-employment taxes of $9,180 (15.3% of $60,000).

As you can see, the ability to minimize self-employment tax can be a huge benefit year after year. Should you have questions about self-employment tax, including the implications of your entity decision and IRS elections, you should consult your tax professional.

To qualify for S Corp status, the LLC must meet the following requirements:

1. Be a U.S. LLC;
2. Have only allowable owners (allowable owners include individuals, certain trusts, and estates and does not include partnerships, corporations or non-resident alien shareholders);
3. Have no more than 100 owners;
4. Have one class of stock;
5. Not be an ineligible entity (i.e. certain financial institutions and insurance companies).

The two main disadvantages are (1) accounting and (2) ownership restrictions (this FAQ will focus on Accounting issues as we have a separate FAQ on ownership restrictions).

Remember, in order to get any benefit for S Corp taxation, you must be (1) an owner of the LLC AND (2) an employee receiving W2 wages (then you only pay self-employment taxes on your salary, if reasonable...not the LLC's profits).

As such, the downside to S Corp taxation is the administrative burdens that come with having an employee (if your LLC will have other employees, this is a non-issue as you will be running payroll already and adding yourself as an owner is simple). 

Paying W2 wages requires tax withholding every time payroll is run and quarterly and annual employment tax returns. S Corp taxation also requires an annual federal tax S Corp tax return (Form 1120S).

You'll need to use a real accounting system (something like QuickBooks) or pay a payroll service.  You'll also probably want to hire a CPA to do your taxes if you elect to be taxed as an S Corp.