The year 2018 is still fresh and new with plenty of time to work toward achieving the goals you’ve set for your business. But some things can’t wait. For example, corporations and LLCs that want to elect S corporation status for this tax year have an upcoming deadline.
So before the spring thaw, businesses that have considered an S corp election will want to look more closely at the potential advantages and explore if it’s the right choice for them.
I recommend that business owners talk with their attorneys and tax experts because every company’s situation is different. But I’ll share some general information to help explain some of the potential advantages of the S corporation.
How can an S corporation election benefit a C corporation?
With regular corporate tax treatment, a C corp that pays shareholders some of its profits as dividends experiences something referred to as “double taxation.” The corporation pays federal income tax on its income (after allowed deductions, credits, etc.). Profit distributions to shareholders aren’t tax-deductible expenses for the business, so they don’t reduce a corporation’s tax liability. When the business distributes dividends to its shareholders, that money gets reported and taxed again on the shareholders’ tax returns.
A corporation that meets the IRS requirements (such as having 100 or fewer shareholders) and elects to have S corp tax treatment, however, can avoid double taxation. Rather than the corporation reporting its income losses, deductions, and credits, taxes*, these things flow through to its shareholders. The shareholders report the income and losses on their personal tax returns. Those business profits are taxed at shareholders’ individual income tax rates, thus eliminating double taxation of corporate income.
How can an S corporation election benefit an LLC?
LLC owners who want to minimize their self-employment tax liability may find the S corporation election helpful. For tax purposes, an LLC and its owner(s) are viewed as one entity. So, normally an LLC owner (or owners in the case of a multi-member LLC) pays income tax on all of the company’s profits (similar to a sole proprietorship or partnership).
And those profits are also subject to self-employment taxes (all 15.3% of them!). With S corp tax treatment, however, an LLC’s owners pay self-employment taxes only on wages and salaries paid to them individually, but not on the remainder of business profits.
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How might the recent tax changes affect whether or not to go with the S corp election?
Something corporations will want to consider carefully is that with the new lower corporate tax rate of 21%, staying with the normal tax treatment (double taxation and all) might be more beneficial than switching to the S corporation’s pass-through tax treatment. The individual tax rates on shareholders, depending on their taxable income, may end up costing them more in the long run.