First things first: if your business is anything other than a hobby, or even merely a profitable hobby, you should at least have an LLC. Here’s why.
Second, generally speaking, an LLC is the most flexible, and therefore the most prudent form of business formation for the vast majority of small to mid-sized business owners. The reason why? An LLC provides your business with the liability protection your business requires (and liability should always be at the forefront of a business owner’s mind), but also, because they provide an array of tax advantages in the form of flexibility of options for taxation. Here is a brief breakdown of how exactly you can take advantage of those benefits:
Before diving in, please note: this firm does not operate as, nor hold itself out to be a tax advising firm. Please reach out to your account for more information if you have tax-specific questions after reading this post; if you are in search of a trustworthy tax advisor for your business, please contact us and we will put you in contact with a firm.
If you are bringing home approximately $25,000 from your business earnings each year, you would likely benefit from electing to have your LLC taxed as as S Corporation. Please note, this is an approximate number, due to frequent updates to the United States Tax Code and the variables of each business, you must confirm this with a licensed professional for your business.
For federal income tax purposes, being taxed “as an LLC” doesn’t exist. Becoming an LLC is a legal (liability preventative) based decision. If your business has one member, your LLC will be taxed no differently than an individual, a sole proprietor or partnership. By default, LLCs with more than one member are treated as partnerships and taxed under Subchapter K of the Internal Revenue Code. However, an LLC can elect to be taxed as an S Corporation, which will allow for the business to be taxed as a pass-through entity. Generally speaking, this will be a lower tax rate once a business passes a financial threshold, such as that listed above.
Below is information regarding S Corporations provided by the IRS:
S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
To qualify for S corporation status, the corporation must meet the following requirements:
In order to become an S corporation, the corporation must submit Form 2553 Election by a Small Business Corporation (PDF) signed by all the shareholders. See the Instructions for Form 2553 (PDF) for all required information and to determine where to file the form.
If a business elects to be taxed as an S Corporation, all owners and employees must be compensated with a “reasonable salary”. All earning must be reported on that individual’s personal income tax return, and the owner of the business must pay all Medicare and Social Security taxes for any employee’s salary.
While it may initially seem as if electing to be taxed as an S Corporation may carry burdensome to-do’s, this election will save the majority of business owners tax dollars at the end of the day. If you own a business and have not explored the decision of whether or not to elect S Corporation tax status for your LLC, I strongly encourage you to reach out to licensed professionals to determine if this election is appropriate for you. Reach out to our team here to see if this election is the best next step for your business.