Elite Tax Status, Payment Methods, and More…
Upgrading to a specialty tax status changes how you and your taxes are paid. When you upgrade your LLC to a specialty tax status, you and any other owners are referred to as “Shareholders” instead of as “Members”.
Here are the two options you can choose from:
| LLC | S-Corporation | C-Corporation | |
|---|---|---|---|
| Payment Method | Owners Draw | Salary + Distributions | Salary + Dividends |
| Tax Advantages | None | No Corporate Tax | No Self-Employment Tax |
Upgrading has the potential to save you, and the rest of your company, money by using the unique characteristics of these business entities. The downside of upgrading is your LLC will have different rules, regulations, and taxes to file. Not only is it a new system, but it’s also more complex.
By electing an S- or C-Corp status, your LLC is first taxed as its own business entity. Whatever remains is taxed again as personal income to the Owners and Shareholders.
The Default LLC’s simplicity is the biggest advantage over Specialty LLCs.
Upgrading before your business has the capacity to follow higher maintenance and regulatory requirements can cause you to miss out on the tax benefits.
There’s no rush.
You can always upgrade your Tax Status later on.
If you’re not fully estabished yet, you could miss out on everything that makes S- and C-Corps worth your while.
S-Corporation
You can upgrade your default LLC to an S-Corporation where owners get paid a combination of a Salary and Distributions. An S-Corp’s Distributions are the same as an LLC’s Draw.
The S-Corp is generally more popular because you avoid Corporate Tax. The funny thing is Pass-Through Taxation also gets you out of Corporate Tax, but without all the extra rules and regulations.
Just remember: Your LLC should be consistently profitable before upgrading.
Benefits of an S-Corporation
Some states limit the amount of profits Members can take in a default setup. In an S-Corp, however, there is no limit on how much of the LLC’s profit you and the rest of the Shareholders can receive.
You can optimize your income in an S-Corp and pay less tax by splitting your earnings between salary and distributions. In a default LLC, Members are only paid in Draws/Distributions.
Since owners contribute to the business, you are exempt from paying Self-Employment Tax on your employee Salary yourself. The company pays Social Security and Medicare taxes (i.e. Self-Employment Tax) on everyone’s salary.
Beging that you are both an Owner and a Shareholder, you’re paying Self-Employment tax on all your Distributions. The process is very similar to paying for
How you receive the money depends on whether you work “for” the company and working “on” your company. Owners
S-Corp Requirements
In order to upgrade to an S-Corporation:
- You’re limited to 100 shareholders
- Shareholders must be US citizens residing in the United States
- Owners can only be people (Not groups, organizations, or other business entities, like they can be in a default LLC)
- Owners must have the same class of stock. Certain shareholders can’t have a higher status or more entitlement than other shareholders
These additional rules create more uniformity within the LLC.
S-Corp Election Forms and Tax Forms
To upgrade your default LLC to a specialty S-Corp, complete and file a 2553 Election Form.
➤ MORE: Upgrade to an S-Corp.
Thankfully, there are plenty of online services available to submit these forms and other documents on your behalf. They simplify the process and reduce the headache of dealing with government services and bureaucracy.
Once you’re operating as an S-Corp, you’ll use an 1120-S Form to file taxes. This form is similar to the form full-on Corporations use to file taxes.
➤ MORE: Filing taxes as an S-Corporation.
C-Corporation
You can also upgrade your LLC to the specialty C-Corp tax status. The drawback of going C-Corp is your company pays taxes twice. This is what’s known as “Double Taxation”.
The first tax is the 21% Corporate Tax which applies to all company profits. Your LLC pays the Corporate Tax as its own entity.
After paying the Corporate Tax, your LLC pays salaries to you and the other shareholders based on individual contributions to the business.
In addition to the salaries, you and the rest of the owners receive Dividends.
Shareholder Dividends are considered personal earnings and are taxed a second time. This tax is based on your tax bracket so it varies from one person to the next. Dividends are subject to Self-Employment Tax because only Owners get them.
Even though upgrading to a Corporate Tax Status means paying Double Taxation, one thing you are getting out of is Self-Employment Tax, as we just mentioned above.
Plus, Double Taxation incentivizes owners to keep Dividends within the company. By keeping this money in the business, you are not taxed a second time. Dividends left in the business’s account are still subject to Income Tax, even when nobody claims the money.
C-Corp Election Forms and Tax Forms
To upgrade your LLC to the specialty C-Corp tax status complete an 8832 Entity Classification Election Form and submit it to the IRS.
➤ MORE: Upgrade your LLC to a C-Corp.
Once you’re all set up with your C-Corp you’ll use an 1120 Form to file taxes. This is the same form Corporations use to file taxes.
➤ MORE: Filing taxes as a C-Corporation.
DISCLAIMER:
“Business Initiative” is for general educational purposes only. “Business Initiative” does not offer any legal or financial advice. Anyone considering starting a business should speak with a lawyer, business professional, financial advisor, and tax expert before making binding decisions regarding starting, operating, and growing your business. Use external resources independently of “Business Initiative.” It is the responsibility of every reader to seek legal and financial advice from legal and financial professionals.