This article is for informational purposes only and is not intended to provide legal advice.
As a business owner, you’re always looking for ways to get more cash back during tax season. The good news is S-Corp tax status can help you do just that, even if you’re not actually a corporation.
In this article, we’ll run through everything you need to know about S-Corp tax status, including what it is, how to set it up, and what type of benefits to expect.
What is S-Corp tax status?
S-Corp tax status allows your LLC to act like an S-Corporation when it comes to revenue and taxes, allowing your LLC to become a “pass-through entity.” This allows a business owner such as yourself, who works within two or more roles within their business, to classify themselves as both an employee and a business owner.
As an employee of your business, you will be taxed as a regular employee. That is, you’ll have Medicare and Social Security taxes taken out of your paycheck, while also being the owner of your business, too.
How is this helpful, you ask? Let’s dive a little deeper.
How does an S-Corp pay less in taxes?
One of the biggest benefits of choosing S-Corp tax status is that it allows you to pass by some taxation that you would have to pay if you filed as an LLC.
As an employee, you’ll have a taxable salary that includes federal taxes, state taxes, Social Security, and Medicare. As the business owner, however, you can also receive dividends which are taxed as capital gains — which carries a lower federal tax rate and no Social Security/Medicare taxes.
So, the larger the amount of money you take out as a business owner, the less tax you will have to pay as an employee. You still have to pay yourself a fair wage that’s in line with industry standards, but if you’re running a business with hefty annual profits, that still leaves a lot of room for dividend distributions.
Which businesses can make the switch to S-Corp tax status?
There are some restrictions on what businesses can make the switch to S-Corp taxes. For example, personal services businesses are not allowed to file S-Corp taxes.
If your business falls under one of the following categories, you, unfortunately, won’t be able to opt for S-Corp status:
- Law firms
- Accounting or financial services
- Brokerage services
What other aspects of your business could prevent you from filing S-Corp?
There are other aspects of your business that could be a barrier to filing for S-Corp tax status, including:
- A married owner’s taxable income is $415,000+
- A single owner’s taxable income is $207,500+
- Businesses with 100+ shareholders
- Businesses with several classes of stock (such as preferred stock)
- Shareholders that are registered as corporations or partnerships
- Shareholders that are nonresident aliens (noncitizens that live outside of the country)
What businesses are best suited for S-Corp tax status?
The good news is that most small businesses are a great fit for S-Corp tax status. Many of the S-Corp tax status regulations were put into place to prevent big businesses and their owners from reaping too much benefit from S-Corp taxes.
S-Corp tax status is most helpful for startup to midsize businesses who are just getting on started or growing their business.
How do you know if switching to S-Corp tax status will benefit you more?
The best way to know if S-Corp tax status will benefit you is to talk to a small business attorney like WH Law. Asking a small business lawyer for advice will help you sort out which tax status is best for you. This allows you to put your mind back into your business and put your trust into a professional’s hands instead.
Ready to make the switch?
Assuming your attorney gives you the thumbs up, switching to S-Corp tax status is as simple as filing Form 2553 with the IRS. You’ll have to fill out and file the form before March 15 to be considered for S-Corp tax status for the calendar year, every year.
Switching to S-Corp tax status requires far more complicated tax filings, so if you don’t already have an accountant you’ll probably want to link up with someone. You can certainly file taxes on your own using tax software, but it’s significantly more complex than filing taxes for a regular LLC, so be sure you’re up for the challenge before you make that commitment.
Depending on your state, you may have to file your S-Corp taxes in a different place than most states, which is just another reason to talk to a business attorney. They will help you sort out the benefits of switching, inform you of any changes you need to make needed within your business to be considered, and file your taxes in the right place.
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