I must preface this post with a disclaimer. I am not a tax lawyer, nor should this post be taken as tax advice. Before making an S-Corp election, please seek the advice of a CPA or Tax Attorney. With that out of the way, let’s discuss the election.
I receive calls from clients wanting to form S-Corporations because they believe that an S-Corp saves money on taxes. When a call starts like this, I get the potential client to take a few steps back. First, we determine if filing an S-Corp makes sense in the first place and for example sake, we determine it doesn’t. Our analysis finds that an LLC is the best entity to form for this person, but we know that in a year or so, this person’s business will generate a substantial income. Knowing this, we devise a plan to reduce the tax obligation in the best way possible. The S-Corp election does just that.
As an LLC, a business owner can elect to be taxed as an S-Corporation so long as such election is made within 75 days of the beginning of the tax year. Many businesses make this election at a later point because the tax savings offset any increased administrative expenses. But what are the tax savings?
As an S-Corp or an LLC that has made an S-Corp election, an individual owner reduces their self-employment taxes. With an S-Corp, the owner that works in the business must pay themself a reasonable salary. The IRS does not define what this means, but most CPAs can guide you. The rest of the income can be paid to an owner as a profit distribution, which no self-employment tax is paid. Now, I have over-simplified the tax rules which is why you should consult with a CPA or Tax attorney to better understand. But in the end, an S-Corp election can potentially save a business owner substantial money in self-employment taxes.