When Should I Create an S Corp?

Benefits of an S Corporation

An S corporation allows small business owners to save on taxes and protect assets. Consider an S corporation when self-employment tax is greater than the taxes paid if operating as an S corporation. Extra paperwork and hassle may offset S corporation tax savings.

Tax Advantages and Considerations

  • An S corporation does not pay taxes itself.
  • Profits and losses pass through to shareholders, who pay individual income taxes.
  • S corporations provide liability protection like an LLC without corporate taxes.
  • S corporations allow people to save on self-employment tax by paying tax only on a reasonable salary.

Factors to Consider for Converting to S Corporation

  • The general rule is that an S corporation makes sense when self-employment tax exceeds the S corporation’s additional burden.
  • If your business makes over $100,000 in profits per year, an S corporation could save money by avoiding double taxation.
  • Consider an S corporation when your net business income approaches a reasonable salary for your work.

Conversion Process to S Corporation

  • Newly formed LLCs can file an election for the LLC to be taxed as an S corp. within two months and 15 days of the date the business begins its first tax year.
  • To begin the process of converting an LLC to an S corp, submit Form 2553 (Election by a Small Business Corporation) to the IRS.

Decision Making and Tax Savings

  • At what income level is S corp worth it?
  • There are several instances when it would be beneficial for you to convert your LLC to an S corp, including when self-employment tax is greater than the amount of tax that would be paid if operating as an S corp.

Criteria for Conversion

  • While there is no specific income threshold that universally determines when an S corp becomes worth it, certain factors can guide the evaluation process: Anticipated Net Income and Reasonable Compensation.

Additional Considerations

  • An LLC is a limited liability company, which offers protection to the owner(s) from personal liability for debts and other obligations that a business might incur.

Conclusion

The decision to convert to an S corporation should be based on factors like tax savings, compliance costs, and the level of net business income.

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