Certified Public Accountant

I’m a Service Company and Formed an LLC. Should I Make an S Corporation Election?

{2:42 minutes to read} Twenty years ago, your choices when forming a company were basically to incorporate or not. Now we have an entity called LLC. However, the IRS does not recognize LLCs as business entities.

  • A 1-person LLC files as if it were a sole proprietor.
  • A multiple person LLC (or LLP) files as a partnership.

LLCs  and LLPs can, however, elect to be taxed as a corporation, which then puts them into the situation where the owners must decide if they are going to be a regular C corporation or an S corporation.

When a service company forms an LLC at our firm, we encourage them to elect to be taxed as an S corporation, which can legally minimize the amount of self-employment taxes that owners pay. All income from a service company LLC that does not make the election is subject to self-employment taxes.

Making this election can save a significant amount in self-employment taxes, up to $10,000 a year if planned correctly, and it's all legal.

In an S corporation, the stockholder owner has the right to determine:

  1. How much of the profits he or she is going to allocate as reasonable compensation;
  2. How much they are going to allocate as income from their investment in the business.

However, be aware that the IRS will know if you try to eliminate all self-employment taxes by not taking any compensation that would be subject to self-employment tax. The IRS will come in and determine what reasonable compensation is for you, and that will not be to your liking. The best thing to do is consult with your tax advisor as to what he or she thinks would be reasonable compensation for your type of business.

To repeat, this is for service businesses. This does not work well for real estate or businesses with large capital demands such as heavy inventory businesses.

If you have any questions, please contact your tax advisor or you can contact us at info@gannscpa.com or by calling 914-682-7007.

Stephen J. Ganns, CPA
steve@gannscpa.com