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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 3904
Experience:  Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
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Our LLC is considering changing to an S Corp. WE have done

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Our LLC is considering changing to an S Corp. WE have done some research to learn what the benefits are in doing so but are not really clear if this is a good choice. The very first interest that drew us to this idea was to save money i.e. less taxes for the individual. The fact that with an LLC we were each paying self employment tax (our social security). Members felt heavily burdened by this and as such an S corp was suggested. In an S Corp it appears the business has to pay these taxes (in a way it seems to me you pay for these taxes but now it comes directly through the business and out of your profits).
It is my understanding that as members of an S Corp we also need to pay unemployment but cannot receive benefits. Is this true? As a note our company only operates for 7 months out of the year - we build kit homes and folks are not building in inclement weather months.
Another question that has come up is that the business profits do not need to have social security tax paid on them. Is this true and if so can you enlighten us on what this might mean to us? The same CPA that told us this told us we could have reasonable salaries and take the remaining in profit. Is this true? Of course in this situation a balanced ownership would be ideal? Any light you can share on this is appreciated.
These are the tax/benefit questions. The main initial question is whether we should make this change and as such would like to see what the pros and cons of doing so would be. What does it take to become and maintain an S Corp Versus an LLC? Is filing/record keeping significantly more involved? What would be the advantages to becoming an S Corp? And anything else you can think of to help us understand and make a good choice.
A little about our company - We are registered in Washington State; there are 4 members; we build kit homes; we have one employee; presently the shares are divided with 2 members @ 6%, 1 @ 15% and 1 @ 73%. The percentages may change as the major
Submitted: 10 months ago.
Category: Tax
Expert:  Lane replied 10 months ago.

Lane : Hi. Yes it's the fact that you pay yourselves dividends (over and above those salaries) that'saving on the self employment taxes (Medicare and social security) that saves you tho money.
Lane : if you paid ALL the way down to break-even (all profit) as salary there would be no savings. ... (Company would be paying half and the other half would be deducted from wages)
Lane : But of you pay yourself a reasonable salary and then take the rest of the profit as a Scorp dividends, there is no self emoyment tax on dividends.
Expert:  Lane replied 10 months ago.
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Expert:  Lane replied 10 months ago.
As. Quick follow-up, your understanding c of the self Employment issue is correct. If you go that way, you may want to ask your insurance carrier about 24 hr coverage. (Which will replace what workers comp won't cover
Expert:  Lane replied 10 months ago.

Hi Michael,

Let me see if I can recap... It appears that you keep putting the questions out there, so I'll try to hit on every question here:



You said:

"The very first interest that drew us to this idea was to save money i.e. less taxes for the individual. The fact that with an LLC we were each paying self employment tax (our social security). Members felt heavily burdened by this and as such an S corp was suggested. In an S Corp it appears the business has to pay these taxes (in a way it seems to me you pay for these taxes but now it comes directly through the business and out of your profits)."

Answer:

For LLC's, Partnerships, and Sole Proprietorships, BOTH sides of the social security and medicare (the 1/2 that the corporation normally pays PLUS the 1/2 that the corporation withholds and pays on behalf of the employee) come out of (are paid based on) profits.

All of these entities are what are called pass-throughs, for federal tax purposes (The business itself isn't taxed, but rather the profits (or losses) are passed through to the individual owners on their own 1040 tax return ... any return that is done for the company is simply to calculate how much profit or loss passes through to the person.

An S-Corp is ALSO a pass through... BUT has some traits that make it LIKE a regular C-Corporation. Shareholder employees take a salary, and then any profit above THAT is passed to the shareholders as a dividend (still has to be taxed, because it's a pass-through, but there's no social security taxes on dividends).

That's where the self employment tax savings comes from (the salary part still has the same SS & Medicare cost - half is being paid out of your wages and the other half out your share of the company's profits) BUT the dividend portion of profits (over and above any salaries paid out) has no social security and medicare paid on it.

In other words, as I stated above ... IF you paid every penny of profit out in salary to yourself, the social security and medicare cost (what we call self employment tax, for LLCs) it's just that 1/2 of it would be paid out of wages and the other half paid by the company (out of your profits).

HOWEVER, if you have a profit of $100,000 and pay yourself a $50,000 salary ... there will be NO social security and medicare paid on that $50,000 dividend.




You Said:

"It is my understanding that as members of an S Corp we also need to pay unemployment but cannot receive benefits. Is this true?"

Answer:

The S Corporation remains responsible for paying the Federal Unemployment or FUTA tax in relation to employees, os if you take that reasonable salary, the unemployment taxes ARE paid based on the salary BUT you are eligible for benefits AS an employee (It's only when you try to completely escape the self employment taxes by paying NO salaries and taking ALL profits in dividends that there would be no FUTA coverage - AND in that case the IRS will probably come in and reclassify part of that dividend as a salary anyway if the company is making profits).

But yes, since you are an EMPLOYEE of the company, which you own as well, in an S-Corp you WILL be entitled to the unemployment benefit associated with that salary (Remember however, that the portion you are taking as a dividend is not having payroll taxes taken out, so your benefit will never be as high in relation to your TOTAL earnings as those employees whose ONLY income IS the salary).





You said:

"Another question that has come up is that the business profits do not need to have social security tax paid on them. Is this true and if so can you enlighten us on what this might mean to us? The same CPA that told us this told us we could have reasonable salaries and take the remaining in profit. Is this true?"

ANSWER:

Yes, this is really the same issue as your first question. IF you are being profitable IRS will REQUIRE that you take part of that as salary, and again, this is where the self employment tax savings come in (the dividends - the profit over and above the salary - has no self employment taxes paid on it)




You said:

" The main initial question is whether we should make this change and as such would like to see what the pros and cons of doing so would be. What does it take to become and maintain an S Corp Versus an LLC? Is filing/record keeping significantly more involved? What would be the advantages to becoming an S Corp? And anything else you can think of to help us understand and make a good choice.
A little about our company - We are registered in Washington State; there are 4 members; we build kit homes; we have one employee; presently the shares are divided with 2 members @ 6%, 1 @ 15% and 1 @ 73%. The percentages may change as the major..."

Answer:

All you have to do to become an S-Corp is file IRS form 2553 - Form 2553

You need to do this by March 15 of next year for it to be effective for the 2014 tax year. Ideally you'd want it to be filed before the end of the year. This will make all of the things happen that we've been discussing above. (no self employment tax on dividends, etc)

One thing that you should know about S-Corps is that the dividends have to paid out in exact proportion with ownership percentages.

If you remain as an LLC, you can (in your operating agreement) set up profit, losses, gains, etc. etc to be shared in any way you like. With the S-Corp, because you're now SHAREHOLDERS, the profits and losses will be distributed on a k-1 to be carried to your personal return in the same proportion as the shares you ow (percent of the company owned).

The cost for that tax benefit on the self employment taxes is the more rigid structure of the S-Corp, the need to do payroll taxes quarterly (when you have income), the need to file and 11230-S (S-Corp tax return, which then issues K-1s to each owner to be carried to their own return), etc.

SO yes, more ADMINISTRATIVE overhead with the S-Corp and less flexibility.

In my opinion it comes down to whether you are regularly profitable enough that there will be significant Self employment tax earnings.



Hope this helps

Lane

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Customer: replied 10 months ago.

Thank you for the through explanation.


 


I have been told that an LLC can be set up identically to that of an S Corp for taxes. That the owners can be employees and that this benefit of no social security tax on dividends can be applied as well.


 


What was said is I do not know who told you the LLC could not pay you wages as employees of the LLC, but they can. The S Corp is the predecessor of the LLC, everything the S Corp can do is the same and the laws are virtually identical.


 


Is this true to your understanding? Are we better off just restructuring our tax set up of the LLC?

Expert:  Lane replied 10 months ago.

Hi Michael.

I have been told that an LLC can be set up identically to that of an S Corp for taxes. That the owners can be employees and that this benefit of no social security tax on dividends can be applied as well.


Actually the way that's done is you set up the LLC (and that's always you underlying business) but then file that 2553 for to be TAXED as an S-Corp.

 

So it kind of runs in tandem; The state sees you as an LLC (only certain states even recognize the S-Corp status ... I can check that for you) but once the S-Corp status has been elected with IRS, you'll do you TAXES as an S-Corp with IRS ... which is where that non-self-employment dividend treatment comes from.

 

 

 

 

What was said is I do not know who told you the LLC could not pay you wages as employees of the LLC, but they can. The S Corp is the predecessor of the LLC, everything the S Corp can do is the same and the laws are virtually identical.


You CAN set up employees with wages in the LLC, BUT for all LLC's, Partnerships and Sole Proprietorships the OWNERS will have self-employment tax on everything. (It's only in the S-Corp taxation treatment that you can exclude proeift -AFTER WAGES- as dividends and pay no self-employment taxes.




Is this true to your understanding? Are we better off just restructuring our tax set up of the LLC?


Just simply use IRS form 2553 to ELECT S-Corp tax treatment OF your LLC and that gets it done:

Here's the form: Form 2553

And here are the instructions: Instructions for Form 2553 (HTML)


Lane


Customer: replied 10 months ago.

Thank you.


 


I want you to know that I am talking with you and another "expert". His recent reply,s similar to yours is that we use tax form 8832 which is how we ask to have the LLC taxed as a corporation.


 


Is this the same as the form 2553 you mention? or..?

Expert:  Lane replied 10 months ago.


Was just about to post this article for you as a general read...

http://www.nolo.com/legal-encyclopedia/why-you-might-choose-s-corp-taxation-your-llc.html



But no, the other expert has missed this piece:

"LLCs electing classification as an S corporation are not required to file Form 8832 to elect classification as a corporation before filing Form 2553.

By filing Form 2553, an LLC is deemed to have elected classification as a corporation in addition to the S corporation classification. "


Lane
Expert:  Lane replied 10 months ago.


Here's our IRS citation on that Michael:

http://www.irs.gov/publications/p3402/ar02.html#en_US_publink1000244352

Read the very first paragraph.



Lane


If this HAS helped, I would appreciate a feedback rating of 3 (OK) or better … That's the only way they will pay us here.

HOWEVER, if you need more on this, PLEASE COME BACK here, so you won't be charged for another question.

Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 3904
Experience: Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
Lane and other Tax Specialists are ready to help you
Expert:  Lane replied 10 months ago.
Hi MICHAEL ,


I'm just following up with you to see how everything is going. Did my answer help?


Let me know,
LANE
Expert:  Lane replied 10 months ago.
Hi there


Again the 8832 IS NOT NEEDED here.

"LLCs electing classification as an S corporation are not required to file Form 8832 to elect classification as a corporation before filing Form 2553.

By filing Form 2553, an LLC is deemed to have elected classification as a corporation in addition to the S corporation classification. "

... hope my answer helped.

Here the citation for that: http://www.irs.gov/publications/p3402/ar02.html#en_US_publink1000244352

Let me know...
Lane

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