Deciding on a legal entity for your business requires understanding the pros and cons of each entity for your specific service.
Many of you already have a legal structure set up—but how much are you benefitting from this structure?
In this article, we’ll discuss the differences between operating as a single-member LLC and as an S-Corporation to help you understand how your business can benefit from the proper legal entity.
We’ll also be discussing how the new tax reform will impact your choice, whether you’re an LLC that wants to switch or a happy S-Corp.
Here’s how you can know which legal structure will benefit your business the most.
What’s the Difference?
First, let’s touch on the similarities between operating as an LLC and an S-Corp.
Both an LLC and an S-Corp provide legal protection between business assets and personal assets, making you less likely to be affected in the event of legal action against your company.
An LLC and an S-Corp also both serve as pass-through tax entities, which means profits and losses will flow through to the business owner.
The amount of taxes you pay will be based on your net profits, which is what’s left after you subtract your deductions from your gross business income.
Now, onto the differences.
An LLC’s entire profit will be subject to self-employment tax, which is 15.3%. There is no “employer” who will pay half of your income taxes for you. You’ll also be subject to state and federal income tax. Remember, the more money you make, the higher your tax bracket will be.
With an S-Corp, you basically become an employee of your corporation, which means you’ll pay yourself a salary and a dividend. Your dividend, or distribution, will not be subject to the self-employment tax but must be reasonable according to the IRS.
The IRS dictates this because it would obviously be more beneficial for many people to just shift more money towards their dividend rather than their salary in order to avoid the self-employment tax.
An S-Corp allows your income to be taxed at your personal tax rate rather than the corporate tax rate. The corporate tax rate was lowered from 35% and is now capped at 21%.
The Impact of the New Tax Cuts and Jobs Act on S-Corps
Since President Donald Trump signed the Tax Cuts and Jobs Act into effect in December 2017, American taxpayers and businesses have been impacted by the changes.
The two most important changes to note are:
- Businesses cannot write off entertainment as a business expense anymore; these include meals, sports tickets, and other events.
- S-Corps can now deduct 20% of their dividend to not be subjected to state and federal taxes.
These changes will be most beneficial for cooperatives, which make up a diverse section of taxpayers. The new tax reform is intended to stop people who make over a certain amount of money from benefitting, but they can exploit a gap—anyone who has their profits go through a cooperative.
Cooperatives are typically associated with farmers and progressive collectives, but in truth, people who make significantly more money than these people can still use this avenue to benefit on their taxes.
With a 20% deduction allowed for pass-through entities such as S-Corps, which pay taxes as innt-weight: 400;”dividuals and not as corporations, people who are in the top tax bracket can effectively lower their taxes to under 30%.
The tax bill is incentivizing people who are in higher tax brackets to change their legal entities to take advantage of this deductible 20%, however, it’s important to note that this deduction doesn’t apply to every business.
Most business owners who are in a higher tax bracket will not be able to take advantage of the deduction because the law has prevented it; this includes doctors, lawyers, and financial advisers. Therefore, these professionals are attempting to redefine their business in order to take advantage of this tax deduction.
If My Business Is an LLC, Can I Become an S-Corp?
For businesses that are already LLCs and want to become S-Corps, this is possible if you qualify.
Qualifications include having fewer than 100 owners, organized under laws of one of the 50 states, no nonresident alien members, and none of the other members can be other business entities except for eligible non-profits.
You can submit the paperwork to change from an LLC to an S-Corp with your tax return, but the change might not be effective until the following tax year.
You must file form 2553 (if filing with your taxes, file form 1120S then attach form 2553) no more than six months from the date on which the tax return is due.
In order to attempt and make your change valid from the current year, which will be reflected in next year’s return, you must file form 2553 no more than 2 months and 15 days from the start of the company’s tax year. All members of the LLC must consent to the election at the time of filing and sign the form.
Although the Tax Cuts and Jobs Act was passed in 2017, many of the details aren’t yet confirmed by the IRS. The IRS will need to issue regulations about the tax deductions, and it’s not yet known what details the IRS will provide clarity on. 365 BOOKSPRO can work with you to keep you informed as guidance is issued.
Businesses that utilize an S-Corp designation can save more on their taxes, but only if done through the proper channels. An experienced tax professional can help your organization make the most use of the new tax laws to help your business benefit in the long run.
Contact the tax professionals at 365 BOOKSPRO to find out how your business can take advantage of these revenue-saving tax strategies!