Small business owners put a lot at risk depending on their business structure. Protecting your personal assets often becomes a serious consideration, and of course, like everyone, you want to lower your tax liabilities.
Forming an LLC or corporation isn’t enough to lower your tax burden, though. Many companies take the S-Corp election to pass their income until shareholders to lower the business’s tax burden.
What Does it Mean to Take the S-Corp Election?
When you take the S-Corp election, your business doesn’t pay corporate taxes. Instead, the income, credits, and deductions are passed down to every owner and/or shareholder. The income is reported on each owner/shareholder’s individual tax returns, reducing the tax burden of the company.
It’s important to understand that an S-Corp isn’t a business entity. You must choose your business entity, such as an LLC or corporation before electing the S-Corp status.
How to Qualify as an S-Corp
To take the S-Corp election, you must meet the following requirements:
- Be a U.S company
- Have less than 100 shareholders
- Have one stock class
- Not be a financial institution, insurance company, or international sales company
When do you File for S-Corp Status?
You have until 2 months and 15 days after the first day of your tax year to elect S-Corp status. Most businesses use the traditional tax year, so this means you have until March 15th to elect the status.
If your business runs on a different fiscal year, you must elect by the 2nd month and 15th day of your tax year.
Filing for S-Corp Status
To file for S-Corp status, you must file Form 2553 no later than 2 months and 15 days past the first date of your tax year. Along with filing the form, you must:
- Have a registered name for your business
- Name your board of directors
- Create and file your bylaws
If you file the form late, you must have ample reason and put it in writing for the IRS. They can accept or deny your request, though. It’s best to file the form on time.
Why Choose an S-Corp?
You might wonder why you’d go through the additional hassle of filing for an S-Corp. Here are some of the most common reasons:
- You won’t be double taxed (corporation income gets taxed at the business and individual level)
- You can use the cash accounting method which is easier
- You can easily transfer the business under the S-Corp status
What about an LLC?
In order to legally set up an LLC, you must file the necessary paperwork with the Secretary of State. This includes registering the business name, members, registered agent, and other details.
Depending on the state, you must also publish the notice in an “approved” newspaper for a specified period of time. You should read the regulations carefully before filing, and take note of any exceptions or restrictions that may apply. Listed below are the steps for setting up an LLC.
An LLC has many advantages over a corporation. It protects the owner from any business debt or liability. As an example, the shoes store Jimmy’s has a large debt to his creditors because he is not a shareholder. By setting up an LLC, he is protected from any debt incurred by the business.
And, while he may be able to pay off the debt in an LLC, he will have fewer obligations to creditors and won’t have to worry about the tax burden on his personal assets.
Before filing articles of organization, be sure to work out a working operating agreement. This is an important step because you may not want to make changes later if your partners don’t agree with the changes.
Even if the LLC only has one member, get everything in writing, especially the operating agreement. This is crucial for protecting your interests and the legal status of your business in the event that one of the owners becomes incapacitated.
| Pros | Cons |
|---|---|
| Avoids Double Taxation | W2 Required |
| Pass-Through Tax Structure | Higher Tax Preparation Costs |
| No Employment Tax | Single Share of Stock |
| Limits Audit Risk | Less Tax Flexibility |
Final Thoughts
If you’re thinking about filing an S-Corp election, make sure you meet the requirements and are prepared to elect it early enough in your tax year. You can lower your company’s tax burden while also decreasing your personal liability by forming either an LLC or a corporation.
As long as you own a ‘simple company’ with one class of stock and no more than 100 shareholders, you may be eligible to elect this status and lower your tax liabilities.