LLC with SCORP option for tax purposes?

[Nicole W.]

Hi all,

I just formed my first LLC and received some information that if I elected the scorp option for tax purposes, I could reduce my tax burden. Is anyone familiar with this strategy? If so what are the pros and cons? Is this something that has to be done every year at tax time or is it a one time election. Any help would be greatly appreciated.

Currently I am going to use it for a business and then eventually place investment property inside.

[Daniel Chang]

@Nicole W.

Yes there are differences especially if you were to be in active business (ie flipping or brokering).  The primary difference s the treatment of self employment tax.  

You state you will use it as a business. You may gain more favorable tax treatment in an S-corp. The traditional LLC is taxed as a Partnership (or disregarded entity if you are an individual). As such, as a partner, you do not employ yourself. Your income is the profit after expenses are deducted. Hence the entire profit is subject to SE tax.

As an S-corp, you would typically need to pay yourself a salary, which is an employment expense.  The remaining profit is an distribution, which is not subject to SE tax.  Now obviously, one "strategy" is to lower your salary to yourself so you have less SS/Medicare tax to pay and more "distribution".  The IRS is obviously very keen on this.  You need to make sure you pay yourself a comparable salary to others in your profession.

Example.  Say your are a RE agent.  If you are just mega-awesome and bring home $500K a year.  As a disregarded entity, the entire $500K (less expenses) is subject to SE tax.  So you would then set up an S-corp and pay yourself a comparable salary to other RE agents, say $75K.  You would pay SS/Medicare on the $75K, but the rest of the profits would be a distribution and not subject to SE tax. If the IRS comes knocking, you need to be able to back up the chosen salary you paid yourself.

Once you make an election, it's considered permanent. You can change it once every 5 years I believe, but will need a plausible reason to.

disclaimer: I AM NOT AN ACCOUNTANT.