Some LLCs and corporations (if they meet the IRS’s eligibility requirements) may choose to be taxed as an S Corporation. But what does that mean exactly?
With 2019 just beginning, now is a perfect time to consider whether an S Corp election might benefit your business. Moreover, the deadline for choosing tax treatment as an S Corporation is fast approaching (March 15) if your business tax year aligns with the calendar year and you want to be treated as an S Corp in 2019.
Whether an S Corp election will benefit your business depends on various factors. To fully understand how it would impact you, talk with an attorney and tax adviser for expert guidance suited to your specific situation.
Potential S Corp benefits for LLCs
Many LLC owners have found they can decrease their tax liability by filing for the S Corp election. Normally, all business income and losses flow through to LLC owners’ personal income tax returns. As a result, owners pay income tax on all of their company’s profits—and that income is also subject to self-employment taxes (Medicare and Social Security). However, with S Corp tax treatment, owners only pay self-employment taxes on their personal wages and salaries that the business paid them.
For an LLC to make the S Corporation election, it must first file IRS Form 8832 (Entity Classification Election) to be classified as a corporation for federal tax purposes. Then it must submit IRS Form 2553 (Election by a Small Business Corporation) to elect S Corp status.
Potential S Corp benefits for C Corporations
Normally, C Corps experience something known as “double taxation.” The corporation pays federal income tax on all of its income (after allowed deductions, credits, etc.). Some of that income gets taxed again at the individual taxpayer level when it’s given as profit distributions to shareholders.
Choosing the S Corp election (by filing IRS Form 2553) allows corporations to avoid that double taxation. When treated as an S Corporation, essentially all business income and losses flow through to shareholders’ personal tax returns. The corporation does not pay taxes on it (with the exception of certain built-in gains and passive income at the entity level). As a result, the business’s income is taxed only at the applicable tax rates for individuals, not at the corporate income tax rate.
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The effect of tax code changes
I’d be remiss if I didn’t mention that the recent tax changes may influence whether choosing S Corp election will be a win for a business.
With the new lower corporate tax rate of 21%, some C Corps might pay less in taxes by sticking with the traditional tax treatment (even with double taxation factored in) than undergoing S Corporation pass-through tax treatment. Why? Shareholders’ individual tax rates (depending on their amount of taxable income) might be higher than the corporate tax rate.
Likewise, LLCs and S Corps may find they will save money by choosing to be taxed as a C Corp. Whether or not they’re eligible for the recently instituted pass-through entity deduction of up to 20% of qualified business income will play a role in how the math works out.
The moral of the story is it could get complicated to determine whether an S Corp is the way to go. That’s why the expertise of a tax adviser and lawyer is imperative.
When is the S Corp election deadline?
According to the IRS, businesses must file Form 2553 “no more than 2 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.”
So, if a business’s tax year started on January 1, 2019, and its owners want it to be taxed as an S Corp in 2019, they would need to file form 2553 by March 15, 2019.
In the case of a new corporation or LLC, it must file form 2553 within two months and 15 days of its date of formation to receive S Corp tax treatment for year 2019
Businesses that want their S Corp election effective in 2020 can file at any time during 2019.
You can find detailed information about filing as an S Corporation on the IRS website. To streamline the process and alleviate paperwork headaches, explore using the services of an online business document filing service that can help you complete and submit your form on time.
RELATED: 8 Mission-Critical Legal Tasks to Tackle After Incorporating Your Business
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