Since its inception, the term “s-corporation” has confused some American small business owners. For starters, almost any small business that has been assigned an FEIN can elect s-corporation status with the IRS and, if applicable, the state. Secondly, the term is used only with regards to the taxation status of the entity and not it’s legal status. For example, any business entity that is an LLC can file an s-corporation election with the IRS by submitting Form 2553.
For tax purposes, it makes sense to convert an LLC into an s-corporation when the self-employment tax exceeds the tax burden faced by the s-corporation.
However, there are some important things to note. First, when does it make sense to file as an s-corporation? One of the biggest and most well-known advantages of an s-corporation over an LLC is saving on self-employment tax. With an LLC, the income passes through to the owner, who has to pay 15.3% self-employment tax. S-corporations, in general, do not make dividend distributions. They do make tax-free non-dividend distributions unless the distribution exceeds the shareholder's stock basis. If this happens, the excess amount of the distribution is taxable as a long-term capital gain.
Next, you need to know that there really is no true, steadfast dollar amount that makes sense for a business to become an s-corporation for tax purposes. Some experts recommend as low as $25,000 in net profit while others recommend as much as $75,000 in net profit. For tax purposes, it makes sense to convert an LLC into an s-corporation when the self-employment tax exceeds the tax burden faced by the s-corporation. Whether taxed as a sole proprietorship, partnership, or s-corporation, all of the above are flow through entities that pass profits and losses onto the personal tax return of the owner.
So how does your business elect s-corporation status? Well unfortunately for most small business owners, the time has already passed for an s-corporation election to be effective in 2022. It is important to note that one must convert to an S-Corp by March 15 in order to be applicable for the following year, or within 75 days of opening the LLC to be applicable for the year of opening. If you miss this deadline, you may apply for late election relief if you have a valid reason for missing the deadline.
Owning a business can complicated, but the tax laws don’t have to be. The professionals at Hampleman Law, LLC can help you decide the best taxation and legal status for your business. Give us a call for a free, initial consultation.