Most people associate the S-election with corporations. But other entities, including sole proprietorships, partnerships and limited liability companies ("LLCs"), are also eligible for Subchapter S treatment. Electing Subchapter S treatment can be a beneficial strategy for reducing employment taxes for many pass through entities.
We receive a lot of phone calls from small business owners who tell me that their CPAs recommended that they form an S-corporation. When CPAs suggests an S-corporation, they mean that you would be better off being taxed under Subchapter S and adding a layer of liability protection. The CPA doesn’t usually care what type of business structure you use.
Fortunately, you do not have to choose your business structure based on your desired tax classification. There are many reasons why LLCs are usually better legal entities than corporations. The very short version is that they require less work and offer better creditor protection. And you can have the benefits of an LLC while also choosing how you wish to be taxed. You can make an S-election and have the best of both worlds.
Before making the S-election, you should carefully analyze the possible benefits. Your CPA can help you make that determination. For many small business owners, the S-election is beneficial because a portion of your income will not be subject to self-employment taxes.
The S-election allows you to save on employment taxes because your earnings can be segregated between wages and distributions. Wages are subject to employment taxes, and distributions are not. However, under the new tax laws, any W2 income is not considered qualified business income, and will therefore be typically taxed at a higher rate tan pass-through income.
It is important to involve an experienced lawyer or CPA when making the S-election. A cursory examination of eligibility and computing the potential savings are the essential first steps in employing the strategy. If made deliberately and with care, the S-election is a powerful strategy to reduce employment taxes under the right circumstances. For other entities, using a corporation of any kind would create future tax problems. Therefore, a careful analysis is necessary in every case.