Should your single member LLC or other sole-proprietorship elect to be an S-corporation effective January 1, 2021? If so, the deadline to elect this option is March 15, 2021.
S-corporations offer many tax advantages. Some of these advantages are detailed below.
Reduced self-employment taxes, assuming reasonable wages are paid.
Self-employment tax is assessed against income reported on a Schedule C (or Schedule F for farmers) at a rate of 15.3%, up to certain limits. In contrast, S-corporation shareholders, as employees of the business, will only be subject to FICA taxes equivalent to 15.3% on the amount of income which constitutes a reasonable wage for the work they perform for the corporation.
For some states, the ability to deduct 100% of the state income taxes attributable to business pass-through income.
The Tax Cuts and Jobs Act limited the deduction for state income taxes and real estate taxes (combined) to a maximum of $10,000 for filers that itemize deductions effective 2018. In response, certain states (including Maryland) have recently passed legislation to allow pass-through entities to elect to treat state income taxes on pass-through corporate income as due from the business vs. due from the owner. This reduces the business’s federal taxable income by 100% of the amount of the state income tax paid during the year. Maryland will provide a state income tax credit to be applied at the personal level to avoid double state taxation. (LLCs operating as partnerships can also benefit from this new provision.)
Limited personal liability.
For sole proprietorships not already operating as an LLC, incorporating can help legally separate your personal assets from your business assets. This can be important if the business is ever involved in a lawsuit.
HeimLantz is ready to perform a projection and cost/benefit analysis to determine which choice of entity is more advantageous to you given the specifics of your current situation. In the event you will benefit from incorporating, HeimLantz can walk you through the process.
Note that although the benefits of operating as an S-Corporation can be substantial, there are a number of cons to consider, which may be important to some taxpayers. These include:
- A corporate tax return will be required each year, even if there is no activity. There are costs associated with filing a separate company tax return and the IRS will assess penalties if no return is filed.
- A payroll service or software subscription will be needed to account for shareholder wages, if not already an employer.
- Filing documents of incorporation and paying annual state franchise filings/fees wherever business is conducted will be required, if not already operating as a single member LLC.
- The 20% QBI deduction will now be based on pass-through income net of the reasonable wages paid to shareholders, vs. being based on 100% of Schedule C/F net income.
- More complex mechanics will apply for deducting health insurance premiums and other fringe benefits for shareholders and some employed family members.
- The deductibility of losses is more likely to be limited.
- A full set of books and records (including balances of asset and liabilities) will be required in order to prepare a corporate tax return, vs. just income and expenses for a schedule C/F.
- An accountable plan will need to be established and followed in order to benefit from home office deductions and commingling of business and personal transactions will need to be more strictly avoided.
- Reduced social security account funding may impact future entitlements.
- A gain may result if liabilities exceed assets at the time of incorporating.
As we stated above, your HeimLantz advisor is ready to help you properly contemplate the pros and cons and determine if an S election will help you save taxes.
If you operate a business or a farm as a single-member LLC that files a Schedule C or Schedule F, call your HeimLantz advisor to discuss the price of this analysis and whether this election could significantly benefit you.