| Looking for an effective tax reduction strategy for | | | | taxation. Sole proprietors, partners and LLC members |
| your small business? This article explains how to | | | | can legally reduce SE tax by receiving reasonable |
| reduce your taxes by choosing to be taxed as an S | | | | employee compensation from the S corporation. If this |
| corporation. Question: What do all the following small | | | | compensation is less than the total business profit, the |
| business owners have in common? 1) C corporation | | | | remaining profit legally avoids payroll tax, because only |
| shareholders; 2) sole proprietors; 3) partnership | | | | employee wage/salary is subject to payroll taxes. |
| partners; and 4) limited liability company (LLC) owners | | | | How do you "choose" to be taxed like an S |
| who are being taxed like a sole proprietorship or a | | | | corporation? This choice is made by filing Form 2553 |
| partnership. Answer: Each of these entity types has | | | | with the IRS, Election by a Small Business Corporation. |
| the potential to pay less tax by choosing to be taxed | | | | Think of this form as an application by an existing small |
| like an S corporation. C corporation owners face the | | | | business to be treated like an S corporation for tax |
| dreaded double taxation of corporation profits. Any | | | | purposes. Here's how it works for each entity type: C |
| corporate profits are usually taxed twice. The | | | | corporation. File form 2553. That's all there is to it. You |
| corporation must pay its own corporate income tax on | | | | don't have to shut down the existing corporation; nor |
| those profits. And if the corporation distributes those | | | | do you have to form a new corporation. The existing |
| profits to the shareholders as dividends, those | | | | corporation continues to exist, just like it did before, as |
| dividends get taxed a second time on the personal | | | | a corporation in good standing of the state in which the |
| income tax returns of the individual shareholders. Ouch! | | | | corporation was formed. Limited liability company. |
| Sole proprietors, partnership partners and LLC owners | | | | Likewise, just file Form 2553. You don't have to shut |
| all face the dreaded self-employment (SE) tax on their | | | | down the LLC and/or form a new corporation. The |
| business profits. And unlike an employee, they pay | | | | original LLC remains intact for legal purposes. You |
| twice as much SE tax (15.3%) than their employee | | | | simply submit Form 2553 in order to tell the IRS you |
| counterparts pay in payroll tax (7.65%). What are all | | | | want your business treated like an S corporation |
| these small business owners to do? One option is to | | | | instead of a sole proprietorship or a partnership. Sole |
| choose to be taxed like an S corporation. An existing | | | | proprietors and partners. Before filing Form 2553, you |
| C corporation that switches to S corporation status | | | | must form a corporation or LLC. Once this new entity |
| can avoid the double taxation of corporate profits. This | | | | is set up, submit Form 2553. Important: There are |
| is possible because an S corporation typically doesn't | | | | specific rules regarding the timing of the Form 2553 |
| pay any corporate income tax on profits. The profits | | | | filing, so be sure to read the instructions carefully or |
| are only taxed to the individual shareholders on their | | | | consult with your tax professional. |
| personal income tax return. End result: no double | | | | |