Saturday, January 14, 2012

LLC? Want to Save Some FICA? Consider an S-Election

More and more LLCs are discovering the advantages of electing a different tax structure while retaining their registration as an LLC under state law.  Time is of the essence in this decision, which must be filed within the first two months and fifteen days of the beginning of the tax year in which the election is to take effect.  That would be March 15th for this year.   

The alternative?  Elect S-Corporation tax treatment for your LLC.  Yes, you can simply decide you want your LLC taxed as if it were an S-Corporation, while legally remaining an LLC. 

Why would you want to do this?  There are several reasons: 
  1. If you're a multi-member LLC, some of your fellow members (and perhaps yourself) might rather get an "ordinary" paycheck and a W-2, rather than a draw or "guaranteed payment" from the LLC.  This includes ordinary withholdings, and considerably reduces the burden of members making large quarterly estimated tax payments.  This is particularly beneficial to minority % members.  It also simplifies distribution of qualified plan benefits, such as a 401(k). 
  2. If you're a single-member LLC, you're currently paying FICA and Medicare taxes on the entire profit of the LLC, including the money you reinvest in the business.  As an S-Corp, you pay FICA and Medicare taxes on only your own W-2 income - whatever is justifiable as "reasonable" for your work in the business.  The remainder of profit is considered that of the entity, and taxable to the members as only ordinary income, as reported on a K-1. 
    That's fair, I believe, considering that some of that income is probably reinvested in the working capital of a growing company.  Why should you pay taxes on money you can't take home? 
  3. Distributions of available cash are still allowed, and with no tax consequences, since they've already been taxed (Less FICA and Medicare -- see #2 above).  They must, however, be distributed proportionally according to membership %, just like an S-Corporation (including yourself). 
  4. You retain the simplicity of the LLC - you still do not need a board of directors, meetings or minutes. 
Why wouldn't you want to do this?  Again, at least a couple of reasons to consider:  
  1. Under an S-Election, your LLC must conform to the same ownership rules and restrictions on distribution of profits and cash as an S-Corporation.  LLCs can distribute cash or allocations of profit (on your K-1) any way they want, regardless of ownership %, which may be a flexibility you don't want to give up. 
  2. You may limit some of your own qualified plan benefits.  For example, your 401(k) match, SIMPLE IRA limits or profit sharing calculations would be done on your own W-2 compensation, rather than the entire profit of the LLC.
  3. While you can "undo" your S-Election, it's neither cheap nor simple.   Be sure this makes sense for you before you go down this road. 
This not advice.  It's an idea for you to become knowledgeable of, then validate with your own trusted legal, financial and tax advisors.  Here's a good article as a place to start.

Do remember you have enough time, but not a lot, to get this done for 2012.   March 15, 2012 is the drop-dead date to make an S-Election for this tax year.  

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Terry Weaver

Chief Executive Boards International
Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it

1 comment:

  1. Good Share.I hope more people discover your blog because you really know what you're talking about. Can't wait to read more from you!


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