Should you convert your LLC to an S-Corp?

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Are you thinking of changing your LLC to an S-Corp, here's some points to consider:

LLC owners pay self-employment taxes 

Single-member LLC Pays Income Taxes as a sole proprietorship.

A Multiple-member LLC Pays Income Taxes pays income tax as a partnership: individual partners pay tax based on their share of ownership in the partnership.

For start-ups, the LLC may be the best way to proceed as the compliance rules require less paperwork, are easy to form and have pass-through taxes to your personal tax return.  Note: different states have different rules. Consult a tax professional before making any changes.

Self-employment tax is slightly over 15% 

Self-employment tax is 12.4% for Social Security Tax and Medicare tax is 2.9 % generally on amounts $118,500 (per 2016) and less.  The owners of LLC are required to pay the self-employment tax rate.

Employment taxes

LLC vs. S-Corp. owners: consider the impact of entity choice on Social Security and Medicare taxes.

  • LLCs—owners are self-employed individuals subject to self-employment tax. Therefore, owners must pay self-employment tax on their share of net earnings from the business.  
  • S-Corp—owners who work for their business are employees, therefore, FICA is imposed only on wages paid. Note, owners must receive (and pay FICA on) reasonable compensation for work performed.  S-Corp must file a business tax return.

How are distributions from an S-Corp taxed?

As a pass-through entity, S corporations distribute their earnings through the payment of dividends to shareholders, which are only taxed at the shareholderlevel. Income is taxed only once, when the income is earned by the S corporation, whether the income is reinvested or distributed.

 

Why Would an LLC elect to be taxed as an S-Corp?

A multi-owner LLC is automatically taxed as a partnership by default, while LLCs with one owner are taxed like sole proprietorships (one-owner businesses). However, LLCs may choose to be taxed as a C corporation or S corporation. This is easily accomplished by filing a document called an election with the IRS.

 

2017 Corporate Tax Rates vs. 2018 Corporate Tax Rates

Corporate tax rates, like individual tax rates, are progressive.

For 2017, corporate rates range from 15% to 39% (except for personal service corporations which are taxed at 35%) while individual tax rates range from 10% to 39.6%. While the brackets vary, the rates for individuals and corporations are pretty closely aligned.

The new tax law now provides for a flat 21% tax rate for corporations. One can imagine how that could have been problematic without more changes: If companies were taxed at a lower rate than individuals, the pass-through scheme doesn't work. But creating a new tax rate for the entities would take away the pass-through nature of the entity.

Congress' solution? Business income that passes through to an individual from a pass-through entity and income attributable to a sole proprietorship will be taxed at individual tax rates less a deduction of up to 20% to bring the rate lower.


Before  making any changes, consult with your tax professional to determine which corporate entity works best for your individual situation.  Additional points to ponder: do you meet the criteria established by the IRS to convert your LLC to an S-Corp?


Florida Accounting & Advisers offers a complimentary consultation, call (561) 939-2553 for your appointment.

 

Wendy Ettorre