When to use an S-Corp

Is Converting Your LLC to an S-Corp Right for Your Business? Benefits, Costs, and How to Make the Switch.

Determining whether to elect S-Corporation status is a key decision for many business owners. If you're making more than $45,000 in net income, subject to self-employment taxes, an S-Corp could help you save on taxes, protect assets, and maximize retirement contributions. However, the decision is complex and depends on various factors, including your industry, income level, and business structure.

What is an S-Corporation?

An S-Corporation (S-Corp) is a tax designation granted by the IRS to eligible small businesses, allowing them to enjoy the benefits of pass-through taxation while minimizing self-employment taxes. This is especially beneficial for business owners who want to protect their personal assets and reduce their tax burden.

When a business elects to become an S-Corp, it can significantly reduce the amount of self-employment (SE) taxes they need to pay. Instead of paying SE tax on the entire business income, an S-Corp owner can split their earnings into a reasonable salary (subject to SE tax) and distributions (not subject to SE tax), which helps lower overall tax liability.

LLC Taxed as an S-Corporation

A Limited Liability Company (LLC) that elects to be taxed as an S-Corp is treated the same way as a standard S-Corporation in the eyes of the IRS. The business name will remain unchanged (you’ll still have "LLC" in your business name).

Business owners may start their company as an LLC and later elect to be taxed as an S-Corp when their income reaches a point where tax savings become significant. However, until this election is made, LLCs are taxed as sole proprietorships or partnerships.

LLCs by themselves do not offer any tax savings which is why many business owners opt to convert to an S-Corp as their business grows.

Benefits of an S-Corporation

1. Tax Savings on Self-Employment Taxes
   In an S-Corp, self-employment tax only applies to the owner's salary, not the business's entire net income. This can lead to significant savings compared to LLCs, where all income is subject to SE tax.

2. Asset Protection
   Like an LLC, an S-Corp provides protection for the business owner's personal assets. In the event of legal issues or business debts, personal assets are typically shielded.

3. Retirement Contributions
   S-Corp owners can contribute to retirement plans like a Solo 401(k), which provides tax-deferred growth on retirement savings. This allows business owners to save for the future while lowering their taxable income.

4. Build Corporate Credit
   S-Corps can build their own corporate credit, which can be helpful if the business wants to apply for loans or establish lines of credit.

5. Decreased Chance of Audit
   S-Corps are 15 times less likely to be audited than LLCs, providing peace of mind for business owners.

When to Use an S-Corp

Consider these factors to determine if an S-Corp is right for you:

1. Do You Have Income Subject to Self-Employment Tax?
   Self-employment income is income you earn through your business, such as fees for services or product sales. If you’re earning $45,000 or more in net income, you may benefit from electing S-Corp status. Some common professions that may benefit from S-Corp status include:

   • Attorney | Broker | Chiropractor | Consultant | Contractor | CPA | Dentist | Doctor | Electrician | Financial advisor | Hair stylist | Insurance agent | Internet marketer/Influencer | Manufacturer | Multi-level marketer | Plumber | Realtor | Restaurant owner | Any occupation receiving a 1099 Misc. for SE Income

   If your business generates passive income (e.g., rental income, dividends, capital gains), you don’t need an S-Corp because passive income isn’t subject to self-employment tax.

2. Are There Restrictions on Operating as an S-Corp in Your Industry?
   Some industries have licensing restrictions or other requirements for operating as an S-Corp. Professionals like doctors, lawyers, and brokers must ensure their license allows them to operate under an S-Corp. If licensing requirements are complicated, you might need to evaluate whether the tax savings outweigh the costs of meeting these requirements.

3. How Much Income Do You Need Before an S-Corp Makes Sense?
   As a general rule, businesses with $45,000 or more in net income subject to self-employment tax are good candidates for an S-Corp. At this income level, business owners often save $2,000–$3,000 in taxes by electing S-Corp status.

4. How Will This Affect My 199-A Deduction?
   The 199-A deduction, which allows for a 20% deduction on pass-through business income, is enhanced by the S-Corp election. Business owners can use S-Corp status to strike a balance between salary and net income, which helps minimize self-employment tax while maximizing this valuable deduction.

In Conclusion

The S-Corporation is often the ideal choice for operational business owners in the long run. Don’t let uninformed advice steer you in the wrong direction—be sure to seek a second opinion if necessary. The cost of setting up an S-Corp varies depending on your state and unique situation, with ongoing expenses for annual filings and payroll reports. It’s essential to ensure that the benefits outweigh these costs, and we’re here to help you make that determination. If you need assistance converting your LLC to an S-Corp, we can handle the entire process for you. Reach out to us to discuss your specific situation and make an informed decision.

Disclaimer: This article provides general information about S-Corporations and tax savings strategies. Your business's tax situation may differ based on various factors. We strongly recommend consulting with a trusted tax advisor or lawyer to assess if electing S-Corporation status is right for you. Contact us today to schedule a consultation and discuss your specific needs.