Should My LLC Elect S-Corp Status? When It Makes Sense

Once a business becomes profitable, someone usually says "you should be an S-corp." Sometimes that's great advice. Sometimes it creates more cost and paperwork than it saves. Here's how to tell.

What is an S-corp election?

An S corporation is a tax status, not a type of company you form. An LLC (or corporation) files IRS Form 2553 to be taxed as an S corporation. Your LLC stays an LLC under Washington law; only the federal tax treatment changes.

How it can save tax

As a sole proprietor or default single-member LLC, all your net profit is subject to roughly 15.3% self-employment tax.

With an S-corp election:

1. You pay yourself a reasonable salary through payroll. Employment taxes apply to that salary.
2. Remaining profit can be taken as distributions, which aren't subject to self-employment or payroll tax.

Simplified example: Your LLC earns $100,000 in profit. As a default LLC, about $14,000 goes to self-employment tax. As an S-corp paying you a $55,000 salary, payroll taxes apply to $55,000 instead of $100,000, saving several thousand dollars before costs.

What it costs

An S-corp isn't free to run. Expect:

• Payroll for yourself: a payroll provider, quarterly payroll filings and W-2s
• A separate business tax return (Form 1120-S) due March 15 for calendar-year businesses
• More bookkeeping discipline: distributions, shareholder reimbursements and accurate balance sheets
• Washington employer obligations that can apply when you're on payroll

These costs can eat up the savings if your profit is modest.

When it usually makes sense

An S-corp election tends to make sense when:

• Your business is consistently profitable, often once net profit reaches the range where self-employment tax savings clearly exceed the added costs
• Your profit is stable enough to support a reasonable salary
• You're willing to keep clean books and run payroll on time

When it usually doesn't:

• Profit is low or unpredictable
• You need nearly all profit as salary anyway
• You're in your first months and don't know your numbers yet

The deadline

To be effective for a calendar year, Form 2553 is generally due no more than 2 months and 15 days after the beginning of the tax year (around March 15). A new LLC has 2 months and 15 days from when it begins its first tax year. Late-election relief is available in many cases if you have reasonable cause.

Common S-corp mistakes

• Paying no salary at all and taking only distributions
• Electing before the business is profitable
• Forgetting to set up payroll after the election
• Paying personal expenses from the business account

The bottom line

An S-corp election can save meaningful tax for a profitable business, but it's a commitment. Have your bookkeeper or tax professional run the numbers with your actual profit before you file Form 2553.

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Need help getting this right? TRIG Bookkeeping & Tax Services helps new business owners in Washington with company registration, monthly and annual bookkeeping, and government compliance. Contact us to talk about your business.

This article is general information, not legal or tax advice for your situation. Tax rules and fees change, so confirm current details with the IRS, the Washington Department of Revenue, or a qualified professional.