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We are considering filing a Form 8832 Classification

Election to have our LLC...
We are considering filing a Form 8832 Classification Election to have our LLC considered a corporation by the IRS for tax purposes. Can you tell me what the upside and downside are generally?
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Customer reply replied 5 months ago
I should mention that my wife and I are the owners of a childcare center and the only members of the LLC. We would like to pay my wife a salary for her role as the center's director. We would also like to possibly take advantage of avoiding some self employment taxes by passing earnings through as dividends.
Answered in 40 minutes by:
3/15/2018
Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 14,901
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
Verified

Hi. My name’s Lane …

I hold a law degree (J.D.), with concentration in Tax Law, Estate law & Corporate law, an MBA in finance, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice, to clients on three continents, since 1986.

I’m reading your question now.

Bear with me a moment while I type up my response.

….

Then if you have further questions we can go from there.

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Customer reply replied 5 months ago
Lane,
Thanks. You have been very helpful in the past.

This analysis really depends on your numbers.

...

If you're talking about the regular corporation (referred to as a C-Corporation) you won't really be saving taxes by pulling money out as dividends.

...

A C-Corp is a separate taxable entity (unlike the other entities, called passthroughs, which don't PAY taxes at the entity level) and pays taxes on it's profit at the corporate tax rate of 21%.

...

But if dividends are paid (which come AFTER the corporation pays it's own taxes) the owners are taxed AGAIN, receiving a 1099-DVI, on their own return. (This is the double taxation that you hear about with the C-Corp.

...

With the new 20% pass-through deduction (given to the passthrough entities by the new tax law to level the playing field after C-Corp rates were taken down to 21% - although now a flat tax so regardless of profits the C-Corp pays 21%) S-Corps, sole proprietors, LLC's not taxed as C-Corps and partnerships may actually generate a lower tax rate (on the individual return ... becasue passthroughs don't PAY taxes ... everything's passed through to the 1040.

...

what you may be thinking about (in terms of some payroll tax savings is the S-Corp,

...

For the required salary that must be paid to S-Corp shareholder employees (as IRS calls S & Corp corp owners who are actively involved in the business) there is no difference between the S-Corp and the other passthroughs ... The required W-2 wage has 1/2 of the Social Security and Medicare tax (7.65%) withheld, and the S-Corp (you) pay the employer half (as any employer does) for a total of 15.3% Social Security and medicare tax.

..

But the profits (over and above the required salary and other S-Corp expenses is passed to the 1040 via a K-1 (like a partnership) and on THAT part of the profit, there's no Social Security and medicare tax.

...

SO ... if you are at that point in profit (over and above a reasonable salary - and you can justify a low enough salary) that incremental profit between there and the social security wage base (where no Social Security tax is charged anyway) doesn't have that 153% levied against it.

...

The COST for that savings (if it's there, depending on profit level and salary level) is the rigidity of the S-Corp structure and the administrative overhead (quarterly 941 payroll tax returns, having to pay in Social Security and Medicare at least monthly, a separate tax return with K-1's, and a potentially higher audit risk - IRS scrutinizes S-Corps, especially as it relates to setting a high enough salary so that Social Security and Medicare taxes are being paid.

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Customer reply replied 5 months ago
Lane,Thanks again. We were considering the S-Corp option. I don't think the salary level will be a problem and we already have a payroll service that files all required payroll returns. Would the K-1 filing be expensive. Also, are we required to issue stock an satisfy all other requirements for an S-Corp like meetings, etc? I thought those issues could be avoided since we would still be recognized as an LLC by the State of California in terms of our business organization. We just thought this might be a good way to avoid some of the self-employment penalty.

The K-1 is just a schedule that is part of the 1120-S. (the schedule that transfers that profit over and above the salary and other S-Corp expenses from the 1120-S to the 1040)

...

The w-2 portion lands on line 7 of the return and the K-1 flows through schedule E to line 17 of the return.

...

On the procedural requirements (such as meetings, and issuing stock) you're right. The underlying entity at the state law level is still the LLC.

...

However, because of the need to share profits losses and everything else based on % of ownership (that's the rigidity part), its best to do the tax accounting as if there are shares ... It's really an interesting hybrid ... IRS uses terms like "shareholders" and sometimes it's smart to have a shareholder agreement or a resolution for certain issues, but you're spot on about the fact that this is all a rather contrived thing to make the tax accounting work.

...

Becasue the LLC is still the underlying entity the actual ISSUING of shares, and bylaws, and article of incorporations, etc at the state law level (essentially all corporate law is state law) don't exist. And not only are those not requirements, that would be impossible to do. No secretary of state has a facility for an LLC issuing shares.

...

The S-Corp tax regime is a tax election. S-Corps are NOT an entity type.

...

One of the other issues with these "contrived" or imaginary shares is that you should keep a stock ledger, sho who owns what percentage of the company ( ... who owns these "shares.") .

...

But yes, if you have revenues of 100,000 and expenses of 25,000 and then pay a salary to the S-Corp shareholder. employee of 50,000... that would leave that incremental profit between 75000 and the social security wage base of $128,400 which would flow through the k-1 to line 17 generating a Social Security and Medicare tax savings of (128400 - 75000) x .153 = 8170.20

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Please let me know if you have ANY questions at all, before rating me.

If this has helped, and you DON’T have other questions … I'd appreciate a positive rating (using the stars on your screen, and then clicking “submit")

That’s the only way JustAnswer.com will credit me for the work.

But again, let me know if you need more here,

Lane

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Customer reply replied 5 months ago
Lane,
One final question since we are up against the deadline to file for this change. Do I file the 8832 first and then the 2553 or do I send them in together?

You don't need an 8832. Since the advent of the check the box rules you only need to 2553.

...

the 8832 would be used to elect C-Corp status

Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 14,901
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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Lane and 87 other Tax Specialists are ready to help you
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Customer reply replied 5 months ago
Awesome. Thanks again for your help. Will definitely rate five stars.

You're very welcome. Thank you.

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