Question

I own a single-member LLC and file a Schedule C with my Form 1040 individual income tax return. My friend thinks it may be beneficial for me to form a S Corporation.

1. What is the main advantage of forming a S Corporation?

2. Is a S Corporation a pass-through/flow-through entity?

3. Would I still have to make estimated tax payments?

4. Would I still have to pay self-employment tax?

5. What is the self-employment tax rate?


In 2017 my business income was $150,000. A reasonable salary comparison for the work I do is $50,000. Assume my effective individual income tax rate is 15%.

6. How much tax would I have saved in 2017 if I was the only shareholder of a S corporation?

Answer 1

A single member LLC is taxed as sole proprietorships (one-owner businesses). However, LLCs may choose to be taxed as a C corporation or S corporation. This is easily accomplished by filing a document called an election with the IRS. Once this is done, as far as the IRS is concerned, the LLC is the same as a corporation and it files the tax forms for that type of entity.

Most LLCs stick with their default form of taxation. But electing to be taxed as an S corporation can have tax advantages. This can be especially true as a result of the new pass-through tax deduction created by Tax Cuts and Jobs Act. Please see the below calculation to have a clear understanding

There are many facets to the S-Corporation vs. LLC discussion.

1. The key advantage of an S corp is that it offers tax benefits when it comes to excess profits, known as distributions. The S corp pays its employees a "reasonable" salary, which means it should be tied to industry norms, while also deducting payroll expenses like federal taxes and FICA. Then, any remaining profits from the company can be distributed to the owners as dividends, which are taxed at a lower rate than income.

2. Yes. An S corporation, like a typical LLC or sole proprietorship, is subject to pass-through taxation. In other words, the responsibility for paying income tax passes through the business to you personally.

3. Yes. Please see the explanation given below

In case of Self-Employed Persons or Sole Proprietor Business Owners.- Those who have income from their own business will need to make estimated tax payments if their tax liability is expected to be more than $1,000 for the year. This includes both part-time and full-time enterprises.

In case of S Corporation Shareholders - Business ownership earnings usually will require estimated tax payments. In the case of corporations, estimated tax payments must be made if the corporation is expected to have at least $500 in tax liability.

4. No. S corporations do not have to pay self-employment tax. Please see the table given above.

5.  The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

6. The total tax saving will be 15,300( 22950- 7650). Please see the table for calculations.

Note:

As a single member LLC your entity is considered a “disregarded entity” for federal tax purposes. That means that while you have the limited liability protection afforded an LLC, you’re taxed the same as if you were a sole proprietor in that all of the profits and losses flow down directly to you as an owner.

One potential downside to this structure is paying the self-employment tax on the profits generated by the LLC. However, as the owner of a single member LLC, you do have the option of making an S corporation tax election for your entity. Like a single member, or multi-member LLC, an S corporation is considered a pass through taxation structure.

So why consider the S corporation tax election if they both are pass-through entities? The most common reason is to avoid self-employment taxes on the profits the entity generates.

By making an S corporation election the owner can now make themselves an employee of the entity, pay his/herself a reasonable salary (and take note that the IRS is serious that the salary must be reasonable), and take any other profits left over as a distribution. The distributions from an S corporation do not carry with it any employment-related taxes, while in comparison all profits in the standard single member LLC setup carry with it self-employment taxes.

To elect S corporation tax status, you must file IRS form 2553. There are limitations for when the election can be made as it must be filed within 75 days of forming the company, or by March 15th to ensure it applies to the current year.

Aspects such as what you must set as a reasonable salary when the s corporation election will apply, and the added administrative paperwork make filing the S corporation election a decision you definitely should run by your CPA or another tax expert. Simply making the election to avoid self-employment taxes can be an endeavor you’ll later regret as it does not make sense for all single-member LLC owners.

Additional costs of S-Corporations.

As an employer, the S-Corporation has to pay unemployment taxes. You may also be required to provide other benefits as required by your local area, such as short-term disability insurance. In addition, you have to run payroll for myself. You have to deal with all the federal, state, and local employment forms yourself, or you can also hire a professional payroll service, which can run from $30 to $100 a month.