A key thing to understand about S Corps is that you don't pay employment tax on distributions from the business. A distribution is earnings and profits that pass through the business to you the owner. Basically it's what you earn outside of your employee wages.
Some unique income tax rules apply to S corporations regarding compensation and fringe benefits paid to shareholders who own greater than 2% of the corporation. Under these S corp income tax rules, a greater than 2% shareholder is taxed as a partner in a partnership for fringe benefits received.
Who pays more taxes, an LLC or S Corp? Typically, an LLC taxed as a sole proprietorship pays more taxes and S Corp tax status means paying less in taxes. By default, an LLC pays taxes as a sole proprietorship, which includes self-employment tax on your total profits.
The 60/40 rule is a simple approach that helps S corporation owners determine a reasonable salary for themselves. Using this formula, they divide their business income into two parts, with 60% designated as salary and 40% paid as shareholder distributions.
The right time to convert your LLC to S-Corp
In general, with around $40,000 net income you should consider converting to S-Corp. Depending on your circumstances the breakeven point could even be as low as $25,000 net income.
Personally, I think if your business is making more than $60,000 in profit every year, then you should look into forming an S corp. Keep in mind that we're talking about taxable income, not gross revenue. Your gross revenue is all the money you make from your products and services.
A major disadvantage of an LLC is that owners may pay more taxes. When setting up as a pass-through to owners, they are subject to self-employment tax.
If your S corporation suffers a loss in any tax year, you can deduct your share of the loss against your other sources of income, such as wages you or your spouse earn working for another business, dividends and interest. However, the amount the loss you may deduct depends on your tax basis.
S Corps that lose their “S” status must typically wait five years before being able to re-elect it. As mentioned, deliberately violating one of the rules, such as transferring stock to an ineligible shareholder, is not a good thing.
As long as the shareholders approve, there are no restrictions on purchasing property for rental purposes. There are restrictions on the income derived from the property, though. The S Corporation is taxed as a pass-through entity and profits and losses pass through to its shareholders.
The S Corporation can either purchase the policy in your name or reimburse you for the premiums you paid.
Some business owners wonder, "Am I considered self-employed if I own an S Corp?" Owners of S Corporations are "employed by" the S Corporation and receive a salary. This means that strictly speaking, you are not self-employed since you're considered an employee of the company.
Single layer of taxation: The main advantage of the S corp over the C corp is that an S corp does not pay a corporate-level income tax. So any distribution of income to the shareholders is only taxed at the individual level.
Because S Corps are pass-through entities, you have to report your business's income on your personal return whether you actually receive it as a distribution or not.
LLC members don't need to pay themselves a salary, but doing so helps to separate personal and business profits, which can support your personal liability protection, among other personal benefits.
While most people associate the business form the Limited Liability Company (or LLC) with small companies such as a dry cleaners or hobby stores, the reality is that there is no limitation to how large an LLC can get.
Liability protection can be limited
You will still be personally liable if someone sues you for your own negligence or wrongdoing—even if the accusations are related to your business. An LLC does not protect your assets if you personally guarantee a contract or loan.
You may or may not have heard of the S Corp Salary 60/40 rule. The guideline encourages setting reasonable compensation between 60% and 40% of the business's net profits. The IRS does not set this guideline. It should not be relied on as the only factor for deciding S corporation reasonable compensation.
To be taxed as an S corporation, you must convert your LLC into a traditional corporation (C corporation) with the state, and file IRS Form 2553 "Election as a Small Business Corporation" with the IRS. For your business to qualify as an S corporation, make sure it meets the IRS's specific guidelines.
The S corporation is ideal for most small businesses. An LLC, or limited liability company, offers the same personal liability shield to each of its owners that a corporation offers. The LLC is essentially an organized partnership offering the same protections as corporations, but with much more flexibility.
Thou Shall Not Put Real Estate Inside a Corporation
351, you can't typically remove real estate from an S corporation without tax consequence. Rather, the distribution of property like real estate from an S corporation means any appreciation of the real estate gets taxed when you remove it.
The biggest mistake I see businesses make is starting an S Corp before they have steady cash flow. Then, they struggle to run payroll, and their personal finances take a hit. Don't switch to an S Corp until you have consistent and reliable cash flow to cover the additional costs.