Most business owners will form a limited liability company (LLC) when they establish a business. This is common because it’s easy to register an LLC and there are very few reporting and operational requirements. However, if you are consistently making over $80,000 a year in profit, you could be overpaying in taxes. One way to legally reduce your taxes is to elect S corporation (S corp) status for your business. The list below are advantages and disadvantages for converting your business from an LLC to an S corp.
Advantages of Electing S Corporation
Lower Employment Taxes
- An LLC has to pay self-employment tax (15.3%) on their annual profit.
- With an S corp, the owner is an employee of the business and must pay themselves a reasonable salary. The S corp will pay 7.65% and owner will pay 7.65% on their salary (rather than on the entire profit).
- Example – A business has $150,000 in revenue, $20,000 in expense, and the owner has an annual salary of $65,000 (if S corp status is elected).
- LLC – The business had a profit of $130,000 ($150,000 of revenue less $20,000 in expense) * 15.3% self-employment tax = $19,890.
- S corp – Annual salary of $65,000 * 15.3% (7.65% for employer and 7.65% for the employee portion) = total employment taxes of $9,945.
Qualified Business Income Deduction (QBID)
- An S corp is considered a passthrough entity (similar to an LLC) and is still eligible for the 20% qualified business income deduction.
Medical Premiums are Deductible
- Health insurance premiums paid on behalf of an S corp shareholder-employee (such as family coverage) are deductible for the S corporation. This is not the case for an LLC.
Employee Reimbursements and Accountable Plan
- Various expenses paid by the owner on behalf of the business (such as the home office and mileage deduction) can still be expensed by the S corp through an accountable plan.
- Once an accountable plan is established, the business will reimburse the employee for expenses paid for on behalf of the business (such as home office rent, utilities, cell phone, internet, mileage, etc…). These reimbursements are deductible for the business.
Disadvantages of Electing S Corporation
Additional Administrative Costs
- There are additional administrative costs associated with electing an S corp. These include payroll fees, costs to prepare the 1120S annual tax return, franchise fee (in certain states), accounting, etc…
Limit to One Class of Stock and 100 Shareholders
- S corporations are limited to 100 shareholders. Therefore this business structure would not work for a business with a significant number of partners or shareholders.
- Only one class of stock is allowed. For this reason, if you plan to raise money from venture capital firms or other investors, this business type would not be appropriate.
