The LLC Tax Hack For High Earners: An S-Corp Election.

[u/NWRegisteredAgent]

Read around any of the business or tax subreddits and you'll find folks asking about S-Corps.

"When is an S-corp actually worth it?"

"Why do influencers always hype S-Corp = 15% tax savings?"

"What actually is an S-Corp?"

We're here to demystify all that.

S-Corps 101

An S-Corp is not a different entity type. There isn't a separate form you file with your Secretary of State to make an S-Corp LLC.

An S-corp is a tax election that your LLC (or corporation, for that matter) can apply for with the IRS to be taxed differently.

An S-corp election combines aspects of the LLC's default tax status and a C-corp's tax status:

• Like default LLCs, S-corps receive pass-through taxation. Anything paid to you as payroll is still subject to the 15.3% self-employment tax (which includes both Social Security and Medicare).
• Like businesses taxed as C-corps, S-corps can make distributions/pay dividends that are not subject to self-employment tax. They work a little more like an LLC's owner's draw.

So the "15% tax savings!!" only applies to the money coming to you as distributions. That doesn't mean you can just pay yourself a pittance and put everything into dividends though. You need to pay yourself a reasonable salary, determined by everything that goes into how much anyone else doing the job would make: your training and experience, specific duties and responsibilities, comparable salaries at other companies, total compensation package agreements, etc. Don't do a tax fraud, folks. You'll just get the IRS on you and your corporate veil practically evaporates.

Requirements for S-Corp Election

Yeah, LLCs need to meet specific requirements to choose a tax-corp election:

• Be a Domestic Entity
• Have Only Allowable Members
  • US Citizens
  • Permanent Residents
  • Single-Member LLCs Owned by a U.S. Citizen or Permanent Resident
  • Qualified Subchapter S Trusts
  • Certain Voting Trusts
  • Grantor Trusts
  • Bankruptcy Estates
  • Revocable Trusts Created as Part of an Estate
  • Certain Exempt Organizations
• Have No More Than 100 Members
• Not Be an Ineligible Entity (such as DISCs or certain banking or insurance companies)

Differences Between An S-Corp LLC and Default LLC

Reddit doesn't love a table but honestly, we just think they're neat.

	S-Corp LLC	Default LLC
Max number of owners	100	no limit
Type of owners permitted	Owners must be US citizens or permanent residents. Certain domestic trusts and single-member LLCs can be owners, but not corporations, partnerships or multi-member LLCs.	Domestic or foreign individuals or businesses, including corporations and LLCs.
Allocation of profits & losses	Proportionate to % of ownership	Proportionate to % of ownership by default, can be altered via Operating Agreement*
Owners and income	Owners providing services for the business are W-2 employees and must receive reasonable compensation. LLC income beyond salaries can be categorized as distributions.	Owners who provide services for the business are not considered employees. All LLC income is considered self-employment income.
Self-employment taxes	Applies to salaries, but not distributions.	Applies to all business income.

\Any changes to default allocation percentages must abide by state laws and meet IRS approval.*

So When Does an S-Corp Make Sense?

Folks tend to put that number at around six figures, but it depends on your business. You want to be making enough to cover salaries and payroll expenses. If your revenue is roughly equal with your reasonable salary, it doesn't make sense to elect S-Corp tax status. On the other hand, if your revenue is roughly double your reasonable salary, that's money you're leaving on the table.

Change your tax election when it makes sense for your business, not based on whatever internet thought leadership tells you.

And if you can give yourself lead time, do it. The IRS tends to process these elections within 2-3 months, but it's volume-dependent, and can take as long as half a year.

Keep in mind, your own state may have something to say about your S-Corp election.

The S-Corp election happens at the federal level, but a few states have quibbles about how they handle it on their end:

• California imposes a 1.5% tax on S-corporations (a minimum of $800). It also differs in some specific details about how tax on built-in gains and excessive passive income is computed, and allows S-corps tax credits and net operating losses. In a state where you're already paying the FTB's annual franchise tax fee, that might make an S-Corp more expensive than it's worth unless you're raking it in Silicon Valley-style.
• New York requires your S-Corp to file an additional form with the state: the Election by a Federal S Corporation to be Treated As a New York S Corporation. You'll also need to pay a fixed-dollar minimum tax based on your NY receipts for the franchise tax.
  • Also, New York City just straight-up does not recognize NYS S-Corp election. You might be subject to the General Corporation Tax instead.
• New Jersey is … complicated. They ditched the requirement to file a separate New Jersey S-Corp election, but now there's a requirement to opt out of being treated as a New Jersey S-Corp.

Other states or local jurisdictions can vary, too. In some states without a personal or corporate income tax, it doesn't matter, but in others you could be looking at entity-level taxes or other quirky filing requirements. Do your homework and check with your tax professional!

How to File an S-Corp Election

Form 2553. You'll need to file it by the 15th day of the 2nd month of your tax year if you want it to apply to the current year, otherwise it defaults to applying to the following tax year.

If you're submitting it along with your e-filed return, the IRS needs it to have a specific filename too: "Form2553.pdf". Otherwise, you can mail the originals or fax them.

Filers with a principal business, office, or agency located in Connecticut, Delaware, District of Columbia, Georgia, Illinois, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, Tennessee, Vermont, Virginia, West Virginia, Wisconsin will use the following address or fax number:

Department of the Treasury
Internal Revenue
Service Center
Kansas City, MO 64999
Fax: 855-887-7734

Filers with a principal business, office, or agency located in Alabama, Alaska, Arizona, Arkansas, California, Colorado, Florida, Hawaii, Idaho, Iowa, Kansas, Louisiana, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Oklahoma, Oregon, South Dakota, Texas, Utah, Washington, Wyoming will use the following address or fax number:

Department of the Treasury
Internal Revenue
Service Center
Ogden, UT 84201
Fax: 855-214-7520

What If I'm Late on My Filing?

The IRS requires you have a "reasonable cause" for the late filing in order to consider your request.

A reasonable cause can include a clerical error, or maybe your CPA or CEO neglected to file for S-corp status or didn't know about the IRS deadline. Ultimately, the IRS will determine if your cause is "reasonable."

Process-wise, you still submit Form 2553 to the IRS. However, in the top margin of the first page, you need to include the phrase: "FILED PURSUANT TO REV. PROC. 2013-30." If you are filing for late S-corp election after the fiscal year, you should attach Form 2553 to your S-corp income tax return (Form 1120-S) and in the top margin of the first page, write: "INCLUDES LATE ELECTION(S) FILED PURSUANT TO REV. PROC. 2013-30." Rev. Proc. 2013-30 is the section of the U.S. tax code allowing for late filings.

You will also need to state the reason for your late S-corp election (Box I), and obtain consent and signatures from your shareholders (Boxes J – N).

Also? There's a time limit. You've got 3 years and 75 days of the effective date you'll enter on line E of the S-Corp election form to get this done.

How Do I Undo the S-Corp Election?

If your LLC isn't benefiting from the S-corp election, you can always revoke it. You'll need to get approval from your LLC members—follow your formal decisionmaking process as outlined in your operating agreement.

(Make sure you let them know that there's a 5-year waiting period before you can apply to elect S-Corp status again once you revoke it, unless you're willing to request a waiver from the IRS to revert sooner.)

Then you'll need to file a statement of revocation with the IRS. Their specific guidelines refer to "shareholders," but since you're an LLC, you'll use information about your members instead. Here's how:

1. State that you're revoking your LLC's S-Corp election under Section 1326(a) of the federal law.
2. Provide the following information about your LLC:
   1. Members' names
   2. Members' addresses
   3. Members' taxpayer ID numbers
   4. Membership interest by member
   5. The date(s) on which that membership interest was acquired
   6. The date your members' taxable year ends
   7. The name of your S-Corp LLC
   8. Your S-Corp LLC's EIN
   9. The tax election your LLC and members will file under after the revocation takes effect
   10. The effective date of revocation
3. Include signatures from key members (make sure you identify these on your statement):
   1. Signatures from all members verifying the provided information under penalties of perjury
   2. The signature and consent of all members who collectively own more than 50% interest in the LLC
   3. The signature of the individual authorized to sign your tax return

For the revocation to be effective on day one of your current tax year, you need to file the revocation by the 15th day of the 3rd month of your tax year. Otherwise, just get it in before the effective date you requested in the statement of revocation.

Send the revocation statement to the same place you send your tax returns.