Should Your Business Be an S-Corp?
If you run your business as a sole proprietor or single-member LLC and profits are growing, you've probably heard that an S-corp could cut your taxes. It can help, but it isn't right for every business, and the details matter. Raymond G. Kenney, CPA helps owners look at the actual numbers before deciding.
What an S-Corp Election Is
An S-corp isn't a separate type of business you form. It's a tax election. An eligible corporation or LLC files Form 2553 with the IRS to be taxed under Subchapter S. Business income generally passes through to the owners' personal returns instead of being taxed at the corporate level.
How the Potential Tax Savings Work
As a sole proprietor or single-member LLC, all of your net profit is generally subject to self-employment tax (Social Security and Medicare) on top of income tax. As an S-corp owner who works in the business, you pay yourself a reasonable salary, which is subject to those employment taxes. Remaining profit can be taken as distributions, which generally aren't. The potential savings depend on your profit, the salary you set, and the added costs.
The Reasonable Salary Requirement
The IRS expects owner-employees to pay themselves a reasonable salary for the work they do before taking distributions. Setting it too low is a common audit issue. What's reasonable depends on your role, your industry and what similar work pays.
Extra Costs and Filings
- A separate business return, Form 1120-S, plus a Schedule K-1 for each owner.
- Salary reporting and withholding filings throughout the year for the reasonable salary you pay yourself.
- More formal bookkeeping, since business and personal money must stay separate.
- New York considerations: in most cases New York doesn't automatically follow the federal election. A corporation generally files Form CT-6 to be treated as a New York S corporation, and New York S corporations file Form CT-3-S and pay a fixed dollar minimum tax. New York City has its own rules for corporations there.
When It May Not Make Sense
- Profits are modest or uneven, so the added costs could outweigh the savings.
- You expect losses in the early years.
- You want flexibility in how profits are split among owners. An S-corp allows only one class of stock, and distributions must follow ownership.
- The business or its owners aren't eligible. For example, S-corps are limited in the number and type of shareholders they can have.
Timing and Deadlines
To take effect for a given tax year, Form 2553 generally has to be filed no more than 2 months and 15 days after that tax year begins, or at any time during the prior year. For a calendar-year business, that's generally by March 15. The IRS offers relief for some late elections, and New York's CT-6 has a similar deadline. Planning ahead is easier than fixing a missed election.
How Ray Helps
- Analysis: compares your current taxes with the S-corp setup using your real numbers.
- Election: helps prepare and file Form 2553 and New York's CT-6.
- Bookkeeping: keeps your books clean through monthly bookkeeping.
- Returns: prepares Form 1120-S and owner K-1s through S-corp and C-corp tax preparation.
- Planning: reviews your salary and distributions each year through year-round tax planning.
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Frequently Asked Questions
How much profit do I need before an S-corp makes sense?
There's no single number. It depends on your profit, a reasonable salary for your role and the added costs of the extra filings and bookkeeping. Ray can run a side-by-side comparison for your business.
Can my LLC be taxed as an S-corp?
Generally, yes. An eligible LLC can elect S-corp tax treatment by filing Form 2553, and it stays an LLC under state law. In New York, a separate CT-6 election is generally also needed.
What if I missed the deadline?
The IRS offers relief for some late S-corp elections when there's reasonable cause and certain conditions are met. Talk with a CPA as soon as possible to see whether relief is available.
Get Started
Have questions about your situation? Talk with Ray. Monday–Friday, 9–5.