How an S Corporation can Benefit LLC Owners

Oftentimes LLC’s and S Corporations are talked about as if the choice is either or, but in legal terms they are very different. An LLC is a business structure where an S Corp is a tax classification.

Many LLC business owners choose to be taxed as an S Corp due to some of the tax advantages it provides, however it is important to understand how and when tax savings will apply.

An LLC (Limited Liability Company) is a type of business structure that protects the owner's personal assets from being seized to settle business debts. An owner of an LLC is called a member and the business can be run as a single owner or multiple owner business. 

Many small businesses choose to run their businesses as LLC’s for the simplicity and flexibility the business structure offers.

An S Corp is not a type of business structure, but a tax classification from the IRS (Inland Revenue Services). Before electing S Corp status, a business must incorporate a traditional corporation or have filed for LLC status.

An S Corp is not taxed at a corporate level and profits are passed through the member's personal income tax.

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Below are some of the benefits that LLC business owners can reap by electing to be taxed under S Corp status.

Most states follow the federal rules which state that S Corporations do not have to pay federal taxes at a corporate level. This means that profits or losses are passed on to the members who then declare those profits on their personal income statements and only pay personal income tax.

Income tax can be reduced by offsetting losses against other income from shareholders. This is particularly beneficial for start-up or small businesses. S Corps are therefore exempt from the double taxation that other business structures such as partnerships or traditional corporations have to pay.

Transferring more than 50% of LLC interest can in some cases lead to the termination of the entire entity. In contrast, S Corporations can transfer interests freely without incurring any negative tax consequences.

Another benefit is that property bias adjustments do not need to be made when transferring ownership of an S Corp, nor do they have to comply with any complicated accounting rules.

Cash method of accounting is where income is recorded within the period it is received and payments are recorded in the period they are paid. This method provides an immediate view of the income and expenses whereas the accrual method of accounting is based on forecasted amounts. 

Businesses can save on unnecessary small business tax costs as this is a simpler accounting system which can protect a businesses cash flow.

Not all LLC’s qualify for S Corp status. To qualify to be taxed as an S Corp the following rules apply:

A business that complies with the above rules, may be able to select to be taxed as an S Corp, but in order to take advantage of the tax benefits there are some other factors to also consider.

An S Corp tax calculator is an easy tool that can be used to check whether selecting S-Corp status provides a tax advantage. Information such as the business’s net profit for the year as well as the reasonable salary amounts paid to shareholders need to be on hand before using the calculator.

Final comment: Remember that reasonable salaries can be checked by visiting the US Bureau of Labor Statistics website or by checking salaries offered on various job sites.