S corp elections for LLC owners
Does an S corp election pay for itself?
An LLC taxed as an S corp can stop paying Social Security and Medicare tax on the profit left after the owner’s salary. It also takes on payroll, a separate return and closer books. The question is which side weighs more for your business.
Articles working through each side are on the way.
- Social Security
- Medicare
What it can save
- Payroll
- Its own return
What it adds
What it can save
The savings come from one place
The election does not change what the business earns. It changes how much of the profit carries Social Security and Medicare tax.
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Self-employment tax
By default, an owner who works in the LLC generally owes Social Security and Medicare tax on their whole share of the profit.
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Distributions
In an S corp those taxes apply to wages. Profit paid out beyond the owner’s salary passes through without them.
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The gap above salary
Only the profit above a reasonable salary can save anything, so the size of that gap sets the size of this side.
What it adds
The costs arrive whether profit does or not
An S corp runs more paperwork than a default LLC, and most of it recurs every year the election stays in place.
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Payroll
A working owner goes on payroll, which brings withholding, tax deposits and employment filings, usually through a paid service.
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A separate return
The S corp files a federal return of its own, on top of the owner’s personal return, and many owners pay a preparer for it.
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Closer books
Wages, distributions and expenses have to stay clearly apart, which takes more bookkeeping than a default LLC usually needs.
Reasonable salary
The owner’s salary is what the balance turns on
An owner who works in an S corp has to be paid a reasonable salary before taking distributions. Payroll taxes apply to that salary and not to the profit left over, so the salary decides how much there is to save.
Set it too low and the IRS can treat distributions as wages. Set it high and little remains on the savings side. What counts as reasonable depends on the work, the hours and what similar roles pay.
Where the savings stop
What can empty the savings side
An election that looks worthwhile in general can still lose for one business, usually for one of these reasons.
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Thin profit
With little profit left after expenses, there is not much for the election to act on, while its costs stay put.
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A salary that takes most of it
When a reasonable salary for the work uses up nearly all the profit, almost nothing is left to pay out as distributions.
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Earnings near the Social Security cap
Social Security tax stops at an annual earnings cap, so owners paid close to it have less of that tax left to avoid.
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Benefits tied to wages
Lower wages can also mean a smaller retirement contribution, and can change the deduction some owners take on business income.
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Income that may not last
The running costs come every year. One good year may not cover them if the next one is leaner.
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Missed payroll deadlines
Payroll deposits and filings run on fixed schedules, and penalties for missing them come straight off whatever was saved.
Side by side
What goes on each side
Put your own amount next to each of these and the comparison starts to take shape.
What it can save
- Social Security tax on profit above the salary
- Medicare tax on profit above the salary
- Additional Medicare tax on that profit, for higher earners it applies to
What it adds
- A payroll service and federal and state unemployment tax on the owner’s wages
- A preparer’s fee for the business return, and any extra bookkeeping
- Any state tax or fee charged on S corps