Can you elect S-Corp Status before Year-End? (or should you?)

How would you like to save $10,000 on your taxes this year?

Well, if you're a business owner who is earning at least $25,000 to $50,000 per year in net profit, and you've already set up your LLC, but you have not yet filed for S-corp status, then pay attention, because you're going to want to listen to what I have to tell you today.

It might have a huge impact on the amount of money that you're paying in taxes.

Today, I'm going to share with you how to literally shave thousands of dollars off your taxes in 2021, by filing this one simple piece of paper.

Ready? Let's do this.

There are so many business owners out there, online businesses, consultants, coaches, freelancers, ecommerce, whatever it might be, who are spending way too much money on their taxes.

And the only reason they're doing that is because they don't properly understand what an S corp is, and how it can help them to save money on their tax bill.

They think it is a legal entity. It isn't.

They think they aren't making enough money to have an S corp actually be worthwhile to them, but they are.

They're afraid that they might have to actually hire an accountant, a professional, to help them get this all set up. Well, unfortunately, yeah, you probably do need to do that, but I'm going to talk to you about why that isn't necessarily such a bad thing.

An S corporation is one of the most commonly misunderstood, underused tax strategies for online and business owners.

Today, what I really want to do is demystify for you some of the common questions that I get asked about S corporations and explain to you what the benefits are to using an S corporation in your business. And hopefully by answering all these questions for you, by the end of today, you're going to be able to decide whether or not filing an S corporation before the end of 2021 is something that you should actually be doing.

What is an S Corporation?

So let's start with question number one, what exactly is an S corporation? And this is where a lot of people really get hung up.

They think that an S corporation is actually a legal entity like an LLC or a corporation. It is not a legal entity.

An S corporation is actually a tax election. And basically what that means is when you file your LLC or you file a corporation, you can tell the IRS how you want to be taxed.

So, if you are a corporation, you can either be taxed as a C corporation where you pay, I think it's like 20, 23% as a flat tax off the net income from your taxes. But there's a lot of drawbacks to doing that as well.

Anyway, you can elect to be taxed that way, or you can elect to be taxed as an S corporation. And we're going to talk about what being taxed as an S corporation means here in just a minute, but an S corporation is a tax election.

On the same level, if you're an LLC, you can elect to be taxed as a C corporation or an S corporation or as neither. So there's a little bit more flexibility if you are an LLC.

So, that's the first thing.

What is an S corporation? It is not a legal entity. It is actually a tax election. And it is the way you tell the IRS that you want your entity, whatever that might be to be taxed.

Now, important caveat here is that if you are a sole proprietorship, you cannot elect to be taxed as an S corporation. You are stuck with the default tax status as a sole proprietorship, which is another reason why if you watched this video, it is so important to file your LLC if you're thinking that you want to take advantage of the S election rules.

Who can use an S Corporation?

Now, this is where it gets a bit tricky. You have to have an LLC, as I mentioned before, to set up your S election, or you can own a corporation and elect to be taxed as an S corporation.

Now you can elect to be taxed as an S corporation and then in certain years, if you don't need it, you can withdraw that election. And then you can elect to be taxed as an S corporation again.

There's a lot of flexibility in how you do it. Most people, once they go S election, they don't go back. But you could theoretically, if you wanted to.

To elect that S corporation status, and this is another area where a lot of people make mistakes, you have to either be a US citizen or a US legal resident. And there's some more nuances in terms of who exactly can do it.

But if you are a non-US citizen and you are living abroad, so let's say you live in Europe and you're a European citizen, but you're not a US citizen, you can't take advantage of the S election rules. So you have to actually be living in the United States as a legal resident.

You don't necessarily have to be a citizen, but you have to be a legal resident here, or you have to be a US citizen. If you're a US citizen, you can live wherever you want. It doesn't matter. You can still elect to be taxed as an S corporation.

When can you file an S election status?

Now, this is important. You have to file the S election status within 75 days of when you set up your LLC.

Let's say you set up your LLC earlier this year and you don't think you're going to need the S corporation this year, but you want to take advantage of it next year, that's fine. You have until March 15th of the year that you want to take advantage of that election to actually tell the IRS you want to be taxed as an S corporation.

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What a lot of people ask is they're like, well, I missed the deadline. What can I do about that?

There is actually a procedure on the IRS website that talks about what to do for a late election. That is something that you can do. It does work.

Actually, when I first filed my corporate paperwork, way back in 2010, from my law firm here in North Carolina, I actually forgot to make the election because our son was born and I had so much going on.

Our son came a month early and I wasn't expecting it. And I forgot. And so around about the end of the year, when I realized there had been a mistake, I filed under the late relief procedures and lo and behold IRS granted my request for an exception to give me the S corporation.

Now that is not necessarily a given. You can't guarantee that the IRS is going to give that to you, but if you follow that procedure, there's a good likelihood you will get that S election. If you've got questions, I would definitely recommend reaching out to an accountant for help with that.

So the way you file for S election status is fairly easy. It's a simple piece of paper that you file with the IRS. It's called a Form 2553. You have to sign it in a couple different places, make sure you fill it out correctly.

Again, if you've got questions, see your account, but that's how you tell the IRS that you want to be taxed as an S corporation.

That's pretty much it.

It's like a two-page document that you're going to fill out and send in to the IRS. You're going to mail it in and that's the way you do it. You might be able to do it online. I'm not sure about that.

Benefits of filing an S election

I kind of teased at the beginning. I said, how do you save $10,000 off your taxes?

So, that's based on the example I'm about to give you.

So let's say that your revenue minus expenses for your business, so your net profit for your business before you pay yourself a salary or any distributions, is $100,000 a year. With that $100,000, if you're just either a sole proprietor or perhaps you are an LLC, but you have not elected to be taxed as an S corporation, then you're going to pay 15.3% self-employment tax.

This is like the FICA and the Medicare and all those different things that come out of your payroll. When you pay payroll, if you're working for somebody, you have to pay those too, if you're self-employed, but it just comes out as what's called self-employment tax.

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And the way that gets calculated is when you go and file your tax return in April, they're going to run a calculation. They're going to say if you're self-employed, here's the calculation you need to perform, to figure out what your self-employment tax is.

And in general, there's some deductions and things of that sort, but in general, it's going to be 15.3% of the net income from your business.

Let's take that business and contrast it with another business that had filed that S corporation election. So same exact income, $100,000 in net income, but in this case, the business has elected to be taxed as an S corporation.

So what does that mean? What that means is the owner has to pay himself or herself what is called a reasonable salary.

Now, what is a reasonable salary? A reasonable salary is a salary that one would pay themselves if they were doing the job of that worker in the business.

So if you made $100,000 per year in net profit, and if you hired somebody to do what you were doing for the business, and you would pay them, let's say $35,000 a year, which is roughly one third of the amount of money that you earned in terms of net profit, that may be reasonable.

It might not be reasonable. It's really going to depend in large part on the type of business.

So again, this is one of those things where you're going to want to talk to your accountant to make sure that you understand that you're paying yourself a reasonable salary.

You can't underpay yourself.

I mean, it's okay to overpay yourself, I guess. I mean, you could take it all as a salary if you wanted to, but that would defeat the whole purpose of electing the S corporation.

So let's say you paid yourself a salary of $35,000 a year. That means you're only going to pay the self-employment taxes on the amount that you pay yourself as a salary. Everything else above that, so in this case, it would be $65,000, you're not going to pay that 15.3% tax on, but that $35,000 you pay yourself in salary, you will pay the self-employment taxes on. And the amount, the 15.3% times 35,000, works out to $5,355.

Now the difference between that amount that you pay yourself in self-employment taxes and the $15,300 that you pay yourself, if you did not have an S election, works out to roughly $9,945. That's how I get the tax savings of $10,000 in this example.

But you might be wondering, yeah, that sounds all well and good, but aren't there costs to having an S election? And yeah, there are.

So yeah, there's going to be expenses related to electing, to be taxed as an S corporation.

Notably you're going to have payroll expenses, which is usually around $40 to $50 a month. You're going to have additional tax filings that are going to be due. So you're going to have to actually file a separate tax return for the S corporation. You're probably going to need an accountant to help you.

Now, the other thing I will tell you, and this actually happened to me this year, and this is something to look out for. It was actually a mistake on the part of the IRS. Don't tell them that.

And I have an accountant who took care of it for me, but I got a bill a couple weeks ago for like $1,500 from the IRS saying that I owed a late filing penalty for my S corporation, but we had filed the extension on time in March. And we filed the tax return on time in September.

So I was a little confused by that. I sent the bill to my accountant. They sent a response to the IRS with proof that we had paid everything and done everything we need to do on time.

And I haven't received a response yet, but I imagine what'll happen is the IRS will say, okay, we've waived the penalty. No harm, no foul.

But that's something you need to be aware of. So there are additional rules and penalties that can be associated with an S election that might happen as well. And typically a late filing penalty comes to the tune of $200 a month plus interest in all sorts of stuff that might happen. So you definitely don't want to get stuck in a situation where you have a late penalty for your S corporation.

Anyway, I would say in general, the cost of running an S corporation run from about $2,000 to $3,000 per year. That's just in general. I mean, it could be more, it could be less, depends on how much you do yourself versus how much you hire a professional to handle for you.

Honestly, if you told me Jim, if you give me, let's say even $3,000 on the high end, I'm going to give you $10,000 back in tax savings, that seems like a no brainer to me, right? Like, why wouldn't you do that? That seems like, yeah, I would definitely do that.

As I said at the very beginning, one last thing you need to be aware of here with regard to S elections, if you really want to take advantage of that S election before the end of this year, you really need to hop to it and get that S election filed with the IRS. File that Form 2553.

And then in addition to that, you're going to need to run payroll before the end of the year, because if it's January 1st, you can't run payroll for this year.

You need to run that payroll before the clock strikes midnight on December 31st, which means you're probably going to need to get that payroll in at least a day or two before December 31st, just to make sure that everything gets done in time and you don't have any issues with that.

If you're interested in learning more about S corporations and hearing me talk about some more examples of how an S corporation might work for you and your business, check out this other video I did right here.

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