Tax election

Many business owners don’t know how or when to select the correct tax treatment for an LLC or a Corporation.

All LLCs start off as a “flow-through” entity where all expenses and income are calculated as part of the Schedule C on your personal return and do not require any additional tax changes. So, when should you fill in an IRS form to change from either a single-member or a partnership LLC? Obviously, when your accountant suggests that you should consider using a specific tax election. Do not use an “S” or “C” election unless you’ve discussed the benefits and draw-backs with your CPA.

Here are some simple “guidelines” for you to consider.

2253 or Chapter S

  • An IRS form 2553 can be used to select sub-Chapter “S” tax treatment for an LLC or a Corporation
  • 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 savings in taxes can become significant once your company generates $40,000 – $50,000 per year of profit after business expenses
  • Once your revenue model shows that level of profit, you can file a form 2553 during the months of January/February to change your tax treatment to “S”

8832 or Chapter C

  • All Corporations start out being taxed this way – under Chapter C of the IRS Code
  • The main benefits are the ability to claim additional deductions for medical re-reimbursement or to partner as owners of a trading LLC to increase the allowable business deductions
  • Many Corporations wish to use the benefits of an “S” election and file a form 2553
  • Unless an “S” election is made, all profits remain with the Corporation and all taxes must be reported and paid by the Corporation

As always, discuss the benefits and dis-advantages with a qualified financial professional, since you may end up paying unnecessary taxes on any profits that your business may generate if you change tax elections.

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