Switching your LLC to an S-corp can reduce your tax bill. S-Corps are taxed as regular C-Corporations, meaning that the business itself is subject to corporate income tax. LLCs, on the other hand, are not taxed as a separate entity. Instead, the IRS taxes LLCs as if they were sole proprietorships or partnerships. This means that the LLC itself is not subject to corporate income tax, but the individual members of the LLC are still responsible for paying taxes on their share of the LLC’s profits.
You should change your LLC to an S-Corp only if the benefits outweigh the costs. Both Limited Liability Companies and S-Corporations have their own sets of benefits. If you plan to raise a significant amount of external investment and eventually go public, you should choose a corporation with S Corp status because an LLC cannot issue stock.
The difference in how the profits are taxed is the main advantage of converting an LLC to an S corp. If you receive $200,000 as an LLC member, the total amount is subject to self-employment tax. If you receive $200,000 as an S corp employee, you’ll only pay payroll taxes on what you decide is a reasonable salary, say $120,000. The remaining $80,000 will be subject to income tax but not Social Security.
An LLC is a business structure created under state laws. Self-employment tax of 15.3% on all company profits. Income tax ranging from 10% to 37% on all business income.
These default designations mean LLC owners can’t take advantage of the tax benefits corporations get to enjoy, like no self-employment tax or higher expense deductibility. For these and other reasons, US Congress created Subchapter S of Chapter 1 of the tax code that created the S-corporation tax classification. Any eligible business can elect to be taxed as an S-corporation.
Do a cost destination of how much approximate annual taxes you’ll have to pay as an LLC and as an S-Corp. Compare the costs of forming and running an LLC vs an S-Corp. Compare the total costs and then convert to an S-Corp only if there are significant benefits.
It’s more expensive to run an S Corp than an LLC due to additional bookkeeping and payroll expenses. The tax benefits must be more than the additional costs for an S Corp status to make financial sense. Other than that, an LLC and an S Corp are similar in terms of pass-through income taxation and personal liability protection.
The next step in converting your LLC to an S Corporation is to file Form 2553 with the Internal Revenue Service (IRS). This form must be filed by March 15th of the year in which you want to begin operating as an S Corporation. If you miss the deadline, you may still request S Corporation status, but you’ll need to provide a reasonable cause for the delay.