What is involved if I form an LLC taxed as a S Corp?

Question

I am leaning very strongly toward shortly creating an entity that will let me be taxed as an s corp. It could be an actual s corp, or—option two-- I could create an LLC and ask that it be taxed as an s corp. I would like for the participants with experience in this area to give me their thoughts.

I would like to have a clearer idea of what aspects of s corp regulations kick in if I ask for my llc to be taxed as an s corp. Having something that will always be a one-person business, I hated the thought of needing to have a board of directors, and even having periodic meetings. I am told that with option two there is no requirement to have a board.

With an s corp I need to have a payroll, issuing myself checks, deducting taxes, and sending them to the state and federal government. Am I correct in assuming that with option two, this wold be one of my obligations?

The only feature of the s corp is the tax savings it makes possible. It allows me to pay myself a “reasonable” amount as salary, but transfer to myself the balance as “distribution” and pay no personal payroll tax (medicare, social security) on this balance.

So I would like your feedback, based on your experience, on what other aspects of s corp rules and compliance would kick in if I opt for an llc taxed as an s corp.

Bill Hampton · Answer

@Sylvia Castellanos

If you have rental real estate you should NOT make your LLC an S-corp. A cash out refinance will trigger capital gains tax in an S-corp, but not an LLC. An S-Corp will increase your tax prep fees and turn passive income into active income which means that you will pay more taxes, not less.

If you are a real estate agent or wholesaler with active income a solo 401k is a better tax saving option than an S-corp in my opinion.

Good luck.

Don Konipol · Answer

This whole discussion about S Corp or LLC as beneficial for paying less tax for your real estate "business" depends on the nature of the income generated. The answer for income from operating a real estate related business such as property management, brokerage, or asset management is totally different from investment income. Further the answer for active investment income may be different than for passive investments. Same with long term vs short term capital gains. Entity form results in lowest taxation THIS year may actually result in higher taxation in future years.

This can be a complicated question depending on the makeup of your current income; the makeup of future income; and potential for capital gains (long term) vs ordinary income.

Savannah Wallace · Answer

Hello Sylvia,

You could set up a corporation taxed as an S-Corp where you are the sole shareholder, sole director, and hold all of the officer positions. There’s no requirement for you to add other people to your board.

That being said, a corporation does come with additional compliance requirements such as annual board and directors meetings. Now, you can have meetings with yourself to fulfill these requirements. But, you can set up an LLC taxed as an S-Corporation and enjoy the same tax features as a corporation taxed as an S-Corporation. LLCs do not have statutory requirements to have annual meetings, however, it is still good practice to document any significant changes such as adding managers or members, changing the business activities, moving states, etc.

Like it has been mentioned in other threads, whether the S-Corporation is the correct tax status for you is going to depend on the nature of your business. I do not recommend holding property in the name of an S-Corporation, so if that is what you are looking at doing, I would not go with an S status, a disregarded entity may be a better option.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

Stephen Nelson · Answer

We do a lot of S corporation tax returns. Hundreds.

And in general, an S corporation makes sense when you can save payroll/self-employment taxes, when you need W-2 wages to get the Section 199A deduction, or maybe (maybe) to get a pass-through-entity tax deduction.

You would not set up an S corporation to hold real estate investments typically.

You might set up an S corporation for your real estate brokerage firm, because you're a real estate agent, or for your construction company.

P.S. An S corporation is just an eligible entity (historically a corporation but in recent decades also often an LLC) that's made an election to use the Subchapter "tax accounting" rules. In a sense, there are "Subchapter S" corporations. And there are "Subchapter S" LLCs. Both work the same way. Probably the LLC route is better for small one person ventures.

Stephen Nelson · Answer

This really isn't a lawyer question. It's a tax accountant question. The Section 1362 election a taxpayer makes by filing a 2553 form is basically a decision about which tax accounting rules you use.

P.S. Many of our S corporation clients are law firms. Or law firm partners.

Gary Li · Answer

If all your incomes are Passive Income, you do not need to pay any self-employment Tax as a single member LLC. If all your Incomes are Active Income, or your Active Income are more than $50K, then the S-Corp can save some self-employment tax.

You can not convert the passive income to active income.

Ashish Acharya · Answer

@Sylvia Castellanos Electing S corp taxation for your LLC can offer significant self-employment tax savings, especially if you earn over $40K annually. You're correct that you'll need to pay yourself a reasonable salary through payroll (with tax withholdings and filings), while the remaining profits can be taken as distributions not subject to payroll taxes. Unlike a traditional S corp, an LLC taxed as an S corp doesn't require a board of directors or formal meetings, but you will need to file Form 2553, run payroll, and file an annual 1120-S return with a K-1. The key benefit is tax efficiency, but it comes with added compliance, so it's smart to consult a CPA to ensure it's structured and maintained properly.

This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

Aaron Zimmerman · Answer

You would need to run the calculations side by side as others have mentioned. Do not put real estate in an s corp. This would mainly be for operating businesses.

The main benefit to the S Corp is less self-employment taxes. A simple example. If you make $100k as a single member LLC and are taxed on schedule C, you will get taxed at ordinary income rates + 15.3% self employment tax + state tax. The tax ends up being anywhere from 25% - 50%+ on this income. For this example, let's say you're in the 22% tax bracket and state tax is 5%. In total, you'd be paying 42% before deductions such as QBI and SE tax. After deductions, you're probably paying an effective rate of 32%, so about $32k in tax.

If you convert over to an S corp, you have to take a salary and the rest can be distributions. Assume the same set of facts above and your salary is 50k. Your new income is $50k. You don't pay self employment tax on the other $50k that isn't salary. In total, you're saving around $7,500 (15.3% * $50,000) on self employment. That said, there are fees that eat into this such as payroll service fees, additional filing fees for being an entity, and also some loss of the QBI deduction as well since income is lower)

Stephen Nelson · Answer

I agree people should almost never put real estate they intend to hold for a long time into an S corporation. S corporations are wonderful. They work great a bunch of situations. My CPA firm as I've noted serves hundreds of S corporations. But not for holding real estate.

However some clarifications:

1. Cash-out refinancings potentially can create distributions in excess of basis for partnerships too. So this can be an issue for LLCs treated as partnerships.

2. S corporations don't change the character of passive income to nonpassive income.

BTW I agree that S corporation tax returns are surely going to be more expensive than single member LLCs treated as disregarded entities. But probably not more expensive than LLCs treated as partnerships.

What is involved if I form an LLC taxed as a S Corp?

What is involved if I form an LLC taxed as a S Corp?

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