The year 2018 is still fresh and new with plenty of time to work toward achieving the goals you’ve set for your business. But some things can’t wait. For example, corporations and LLCs that want to elect S corporation status for this tax year have an upcoming deadline.
So before the spring thaw, businesses that have considered an S corp election will want to look more closely at the potential advantages and explore if it’s the right choice for them.
I recommend that business owners talk with their attorneys and tax experts because every company’s situation is different. But I’ll share some general information to help explain some of the potential advantages of the S corporation.
How can an S corporation election benefit a C corporation?
With regular corporate tax treatment, a C corp that pays shareholders some of its profits as dividends experiences something referred to as “double taxation.” The corporation pays federal income tax on its income (after allowed deductions, credits, etc.). Profit distributions to shareholders aren’t tax-deductible expenses for the business, so they don’t reduce a corporation’s tax liability. When the business distributes dividends to its shareholders, that money gets reported and taxed again on the shareholders’ tax returns.
A corporation that meets the IRS requirements (such as having 100 or fewer shareholders) and elects to have S corp tax treatment, however, can avoid double taxation. Rather than the corporation reporting its income losses, deductions, and credits, taxes*, these things flow through to its shareholders. The shareholders report the income and losses on their personal tax returns. Those business profits are taxed at shareholders’ individual income tax rates, thus eliminating double taxation of corporate income.
How can an S corporation election benefit an LLC?
LLC owners who want to minimize their self-employment tax liability may find the S corporation election helpful. For tax purposes, an LLC and its owner(s) are viewed as one entity. So, normally an LLC owner (or owners in the case of a multi-member LLC) pays income tax on all of the company’s profits (similar to a sole proprietorship or partnership).
And those profits are also subject to self-employment taxes (all 15.3% of them!). With S corp tax treatment, however, an LLC’s owners pay self-employment taxes only on wages and salaries paid to them individually, but not on the remainder of business profits.
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How might the recent tax changes affect whether or not to go with the S corp election?
Something corporations will want to consider carefully is that with the new lower corporate tax rate of 21%, staying with the normal tax treatment (double taxation and all) might be more beneficial than switching to the S corporation’s pass-through tax treatment. The individual tax rates on shareholders, depending on their taxable income, may end up costing them more in the long run.
But on the flip side, the new tax law has a provision that allows for individuals who operate pass-through entities (excluding certain professions) to deduct up to 20% of qualified business income (reduced by capital gains), which may not exceed 20% of an individual’s taxable income. In certain situations, that provision might make S corp election a more cost-effective choice.
To understand whether the S corporation election will provide a tax advantage, business owners will want to consult with their attorneys and accountants to evaluate the financial impact and weigh all the legal pros and cons.
How much time do corporations and LLCs have to file for S corp election in 2018?
To make the S corp election effective for the current tax year, existing C corporations and LLCs must file Form 2553 no more than two months and 15 days after the beginning of the tax year. C corporations and LLCs with a tax year that began on January 1, 2018, have until March 15, 2018, to apply for S corp election for the 2018 tax year.
Here’s how the IRS explains it on the instructions for Form 2553: “The 2-month period begins on the day of the month the tax year begins and ends with the close of the day before the numerically corresponding day of the second calendar month following that month. If there is no corresponding day, use the close of the last day of the calendar month.”
New corporations and LLCs that want to file an S corporation election must do so no more than two months and 15 days after their date of formation. Businesses that want their S corp election effective in 2019 can file at any time during 2018.
For more information about the S corporation, visit the IRS website where you’ll find additional details about eligibility restrictions, filing deadlines, and other important information. And if you decide to file for S corp tax treatment, consider using a reputable business registration and compliance filing company to assist you in getting it done right and on time.
*Note that according to the IRS, “S corporations are responsible for tax on certain built-in gains and passive income at the entity level.”
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