The “S” tax election can be applied to either a Corporation or an LLC with identical benefits and filing requirements.
The main benefits to you as a small business owner includes a reduction in the amount of Social Security / Medicare taxes that you would have to pay on company profits and the ability to claim additional deductions for medical re-reimbursement
These 5% – 10% savings in taxes can become significant once your company generates $40,000 – $50,000 per year of profit after business expenses.
Since the “S” election is primarily used to reduce taxes on “earned” income, it is important to understand how any reduction could occur.
Consider this example of wholesaling / flipping.
Total profits after expenses are $10,000. In addition to normal state and federal income taxes self-employment taxes of 15.3% will be collected. Self-employment and Employment and Payroll taxes all refer to the same pair of taxes – Social Security and MediCare taxes.
Normally the employment taxes would amount to $1,530.
If the company has an “S” election, then the employment taxes may be reduced by half to approximately $750 – saving you the same amount in taxes.
In order to “convince” the IRS to provide this tax savings, the company must provide some additional IRS paperwork – quarterly estimated tax payments, payroll / paycheck reporting and an annual company tax return. Since you will probably need to hire accounting and payroll services to provide the needed paperwork, you will have increased costs as well as additional paperwork.
So the calculation is fairly straightforward.
If your services cost more than your tax savings, an “S” election is probably not a good idea until your profits increase.
You can always file the form 2553 for the “S” election next year. The IRS accepts applications until March 15th of any year.