05 May When to Change Your Small Business Entity to an S-Corp
As your business grows, the way you elect to file your business taxes may need to change to get the most tax benefit. Here’s how to know when the time is right to change your small business entity type to an S-Corp.
Congratulations! If you’re reading this it most likely means that you have a small business in a growth state and you’re looking for tax strategies to manage this upward trajectory. Growth stages can be a challenging time as they often create a need for more advanced CRM systems, better inventory management, and additional staff. But changing your small business entity type for tax purposes may actually be one of the easier changes you can make, with potential tax savings both quarterly and annually.
Why You Might Consider Changing Your Tax Filing to an S-Corp
Many small businesses register as LLCs when they start. An LLC is relatively easy to set up and offers a level of legal protection by establishing the business entity as separate from the owner (unlike a sole proprietorship where the owner and business are one in the same). An LLC allows you to deduct expenses like a home office and auto expenses, but it lacks some of the tax strategies that can be used by S-Corps to reduce self-employment taxes.
Let us back up a bit to clarify an important differentiation– an S-Corp is NOT a business entity structure. An S-Corp is a tax election that is available to LLCs and other corporation types for specific tax advantages. So even if you’re a single-member LLC or have multiple members, you may have the ability to file as an S-Corp election for tax purposes. The advantage to doing so is that an S-Corp election allows owners to also be considered company employees.
How is that a tax benefit? In taxation for many LLCs as either sole proprietors or partnerships, the business owners must pay both self-employment tax (for Medicare and Social Security) and income tax on the company profits. In an S-Corp, however, owners are paid a salary that is subject to payroll taxes, but the remaining company profits are only subjected to income taxes.
When Does Filing as an S-Corp Make Sense
If you want to know if an S-Corp makes sense for your small business, ask yourself this, “If my business were to pay me a reasonable salary, how much remaining profit would be left over?” For example, if your LLC expects to make $100,000 for the year and $40,000 would be a “reasonable salary” in the eyes of the IRS, then only $40,000 would be subjected to payroll taxes and the remaining $60,000 could be excluded from payroll taxes when it is disbursed to owners. In that case, filing your taxes as an S-Corp has an obvious and significant tax advantage. If, however, your company’s gross income is only slightly above the amount that would be considered a reasonable wage, then you may be further ahead maintaining your tax filing type as-is.
How Do You File Your Taxes as an S-Corp
There are several qualifications for LLCs to file their taxes as an S-Corp. First, your business must be a United States business and have fewer than 100 members or shareholders. Shareholders may be individuals or certain trusts and estates, but cannot be partnerships, corporations, or nonresident aliens. Also, businesses filing as S-Corps can only have one class of stock.
To convert your business to an S-Corp, you need to complete IRS Form 2553 and file it by March 15 of the year in which you want the S-Corp tax election to take effect. It is always advisable that you discuss this election with your CPA or tax professional before making the change, as the tax code is nuanced for specific business types and is subject to change.
Small Business Tax Filing Questions
Have more questions about whether filing as an S-Corp is the right tax strategy for you? Prestige Business Enterprises is here to understand your business and help you take advantage of the tax benefits that make the most sense for your business goals. Set up a consultation today with our professional tax team by calling Prestige Business Enterprises at 813-774-5866 or emailing us at firstname.lastname@example.org to begin.