Examples:

• Susan’s S Corp had $100,000 in profits. As the sole owner, she pays individual income tax on the full $100,000 but no corporate tax.
• John and Mary’s LLC operating agreement gives John 60% of profits and Mary 40%. If the LLC makes $50,000, John pays tax on $30,000 and Mary on $20,000.
• Bob’s single-member LLC made $80,000 last year. He reports it on Schedule C with his 1040 like a sole proprietor.
• Acme LLC’s Form 1065 showed $150,000 in income. It issued K-1s to each of its 3 members for $50,000 to report on their individual returns.
• Marge owns 25% of Spa Day Inc. The S Corp had $200,000 in profits, so Marge’s K-1 shows $50,000 taxable income from her 25% ownership.

How to Proceed:

• Consult a CPA or tax advisor to understand how pass-through taxation applies specifically to your business situation.
• When forming a multi-member LLC, carefully structure your operating agreement to allocate income/losses in the most tax-advantaged way.
• S Corp shareholders should monitor their ownership percentages, as their tax liability will be based on their pro-rata share of corporate income.
• Single-member LLC owners should track all income and expenses diligently to complete an accurate Schedule C at tax time.
• Review your prior year’s tax returns and K-1s with an accountant to identify tax planning opportunities for the future.

FAQs:

• Can I still be taxed as a pass-through entity if I’m the only owner? Yes, both single-member LLCs (disregarded entities) and S Corps with one shareholder provide pass-through taxation.
• Do I have to pay estimated taxes as a pass-through entity owner? Typically yes, as there is no employer withholding on pass-through income, so you usually must pay quarterly estimates.
• What is the due date for pass-through entity tax returns? Generally March 15 for calendar-year S Corps and multi-member LLCs. April 15 for single-member LLCs.
• Can I change my LLC’s tax allocation percentages each year? Yes, if structured properly in your operating agreement and with the consent of other members.
• Will I get a W-2 or 1099 from my S Corp or LLC? S Corp shareholders receive W-2s for salary and K-1s for distributions. LLC members get K-1s.

Examples:

• Tom’s 50% share of his LLC’s $200,000 profit is $100,000. He pays $15,300 in self-employment tax (15.3% of $100,000) on top of his income tax.
• Lisa’s S Corp paid her a $60,000 salary and $100,000 in distributions. She paid 15.3% SE tax only on the $60,000 salary, not the distributions, saving over $9,000.
• Frank owns 100% of an S Corp earning $150,000/year. He paid himself a reasonable $75,000 salary and took $75,000 in distributions, minimizing SE tax.
• At her CPA’s advice, Jan increased her S Corp salary from $40,000 to $60,000 since she was working 50 hrs/wk and $40k was unreasonably low.
• Sue and Jim split their LLC’s $100,000 profit 50/50. They each pay SE tax on their $50,000 share. As an S Corp they could cut that by paying salaries less than $50k.

How to Proceed:

• Meet with an accountant to evaluate the potential SE tax savings of an S Corp vs LLC for your specific situation.
• If electing S Corp status, work with your CPA to determine a “reasonable salary” for your role and industry to stay IRS compliant.
• Compare your S Corp salary to market data for similar positions to ensure it aligns with IRS guidelines to avoid audit risk.
• Run the numbers to make sure your S Corp salary and SE tax savings will still exceed the cost of required payroll services.
• Don’t overlook state taxes – some charge higher rates or fees on S Corps vs LLCs that may negate SE tax savings.

FAQs:

• Do I have to pay myself a salary if I’m the only S Corp owner? Yes, the IRS requires all S Corp shareholders/employees to take reasonable compensation as W-2 salary.
• Can I take a small salary and large distribution my first year as an S Corp to save on payroll taxes? Not advisable, as the IRS looks closely to ensure salary is reasonable every year based on your duties and market rates.
• Do I have to file quarterly payroll tax returns as an S Corp? Yes, S Corps must file Form 941 quarterly and remit federal income tax and FICA withheld from employee/shareholder wages.
• Can I wait until year-end to determine my S Corp salary and distributions? No, the IRS expects reasonable salary to be paid regularly throughout the year, not as a lump sum at year-end.
• Is there a set formula for a “reasonable” S Corp salary? No, it depends on the nature of your business, your role/duties, hours worked, and comparable market wages. Consult with a CPA for guidance.

Examples:

• John’s LLC netted $100,000 and he files single. His QBI deduction is 20% x $100,000 = $20,000, reducing his taxable income to $80,000.
• Mary and Pete’s S Corp netted $400,000. They paid $120,000 in W-2 wages and had $200,000 in qualified property. Since they are over the married income limit, their deduction is limited to the greater of 50% of W-2 wages ($60,000) or 25% of wages + 2.5% of qualified property ($35,000). They can take a $60,000 QBI deduction.
• Susan’s law firm S Corp netted $350,000. But as a high-earning specified service business, her QBI deduction is phased out completely.
• Joe’s LLC earned $150,000 and he files single. At his taxable income under $170,050, Joe can take the full 20% QBI deduction of $30,000 regardless of wages paid or depreciable property.
• Sam’s S Corp paid $50,000 in wages and had $150,000 in qualified property. His share of business income was$200,000 and he files single. His deduction is limited to 50% of wages ($25,000) or 25% of wages + 2.5% of property ($16,250). Sam can take a $25,000 QBI deduction.
  

How to Proceed:

• Consult with a tax advisor to determine if your business qualifies for the 20% QBI pass-through deduction.
• If close to the income phase-out limits, consider strategies like contributing more to retirement accounts or deferring income to stay eligible.
• If subject to W-2 wage or qualified property limitations, work with your CPA to optimize wages paid and asset purchases.
• Keep detailed records of wages paid, cost basis of qualified property, and other factors that impact your deduction calculation.
• Be aware that the 20% QBI deduction is set to sunset after 2025 unless Congress extends it. Plan accordingly.

FAQs:

• Can I claim the QBI deduction as a single-member LLC? Yes, if you file as a sole proprietor or elect to be taxed as an S Corporation.
• How do I know if my business is a Specified Service Trade or Business (SSTB)? Consult the IRS guidelines or ask your accountant. Generally, it includes fields where the business depends on the reputation/skill of its employees or owners.
• What counts as qualified property for the QBI deduction? Tangible, depreciable property held by the business at year-end and used for production of QBI sometime during the year.
• Can I still take the QBI deduction if my business has a loss? No, the deduction applies only to positive business taxable income. But you may be able to carry forward the loss to offset future QBI.
• Does the QBI deduction also apply to self-employment taxes? No, the deduction only reduces your income tax, not your SE tax or payroll taxes withheld.

Examples:

• Dave’s 50% share of his LLC’s profits was $75,000 last year, on which he paid income and SE tax. This year, he takes a $40,000 distribution, which is not taxable since he already paid tax on those profits.
• After paying herself a $65,000 salary, Linda takes a $50,000 dividend from her S Corp. She pays income tax on the salary but not the dividend.
• Jim’s CPA advises he must pay himself at least a $45,000 salary before taking any distributions from his S Corp this year, to stay IRS compliant.
• Sue’s basis in her S Corp stock is $20,000. If she takes distributions exceeding $20,000 this year, the excess will be taxed as a long-term capital gain.
• Erin and Tom’s LLC operating agreement allows for disproportionate distributions. So even though they each own 50%, they agree Erin can take 70% of distributions this year since she worked more hours.

How to Proceed:

• As an LLC member, make sure you have sufficient basis before taking a distribution to avoid unexpected taxes. Check your capital account and consult your accountant.
• For S Corps, work with your CPA to determine a reasonable salary to pay yourself first, and only then withdraw any remaining profits as a dividend.
• S Corp owners should monitor their stock and debt basis to ensure distributions don’t exceed it and trigger a taxable gain.
• Avoid taking distributions from an S Corp to pay the taxes on your pass-through business income. Pay these from your personal funds to increase your basis.
• LLCs with multiple members should specify in writing how distributions will be allocated, and when they will be paid out.

FAQs:

• Do I have to pay quarterly estimated taxes on LLC distributions? No, but you must pay estimates on your share of LLC profits whether distributed or not.
• Can I take a distribution from my S Corp without paying myself a salary? Not if you are an owner who works in the business. The IRS requires reasonable compensation before dividends.
• Do I owe self-employment tax on LLC distributions? No, SE tax is due on your share of LLC profits, not distributions. You pay the SE tax on your 1040, not when you take money out.
• What happens if my S Corp distributes more than its AAA balance? Excess distributions from Accumulated Adjustments Account (AAA) are generally taxed as dividends or long-term capital gain.
• How do distributions affect my LLC capital account? Distributions decrease your capital account. If your CA goes negative, it can mean unexpected taxes on distributions.

Examples:

• Al formed his S Corp in January and did not make a fiscal year election, so it will operate on a calendar year ending every Dec 31 by default.
• Ken’s landscaping LLC does 35% of its business in the fall. It chooses a fiscal year ending Sept 30 so peak revenues and expenses fall in the same tax year.
• Terry’s law firm lobbies the IRS to approve changing to a fiscal year ending Aug 31. The firm’s billings are lower in Jul/Aug, so this allows shifting more income to next tax year.
• Paul’s dental S Corp uses a fiscal year-end. But his accountant charges more to prepare taxes because extra calculations are required.
• Julie’s LLC considered a Nov 30 fiscal year-end to defer some tax. But her CPA said it wasn’t worth the added complexity since her income is steady year-round.

How to Proceed:

• When forming your LLC or S Corp, consider whether the default calendar tax year makes sense for your business needs and natural sales cycle.
• If you have a highly seasonal business, such as a summer camp or snow plowing service, ask your CPA about the potential benefits of a fiscal year-end.
• Weigh the tax deferral benefits of a fiscal year against the potential added complexity and cost of tax prep and estimated tax calculations.
• Don’t assume you can just pick any fiscal year-end you want. You must request IRS approval and show a valid business reason for your fiscal year choice.
• Just need a one-time tax deferral? An S Corp can make a Section 444 election to change to a fiscal year, but will owe extra tax (deferred LIFO recapture).

FAQs:

• How soon after forming my LLC or S Corp do I need to choose a tax year? Most businesses just begin operating on a calendar year by default. The tax year is officially established when you file your first income tax return.
• Can I change my tax year once I’ve selected it? You can request IRS approval to change tax years by filing Form 1128. You must show a substantial business purpose for the change.
• Must I use the same tax year for both my business and personal returns? No, owners of pass-through entities can have a different tax year than the business, but it can complicate tax planning and increase prep costs.
• How does my tax year impact the due date of my business tax return? Calendar year entity returns are generally due Mar 15 (S Corps) or Apr 15 (partnerships). Fiscal year filers are due the 15th day of the 3rd (S Corps) or 4th (partnerships) month after year-end.
• Do I have to use the same tax year for income tax and payroll tax? Yes, if your LLC elects S Corp status, you must use the same tax year for income tax (1120S) and payroll tax (Form 941) reporting.

Examples:

• While John’s business is legally formed as an LLC, it can still elect S Corp tax treatment by filing Form 2553 with the IRS.
• Mary and Sue’s S Corp has 75 individual shareholders. Last year it accidentally issued 100 shares to a corporation, violating the eligible shareholder rule. It could lose its S status.
• Tom wants his S Corp to issue preferred shares to an investor to raise capital. His CPA advises this would create a 2nd class of stock and disqualify the S election.
• Raul formed his corporation on Nov 15. He must file Form 2553 electing S Corp status by Jan 30 for it to be effective starting this tax year.
• Patty’s S Corp had a banner year but will owe $25,000 in tax. She loans it money so it can pay a non-pro rata distribution only to her. This creates a 2nd class of stock and terminates the S election.

How to Proceed:

• If you are a domestic LLC wishing to elect S Corp status, confirm that you meet all the S Corp eligibility requirements before filing Form 2553.
• Monitor your S corporation’s ownership and distributions carefully to ensure you don’t violate the eligible shareholder or single class of stock rules.
• Stay on top of the deadline to file Form 2553. It’s due within 2 months and 15 days of your intended S Corp start date. Late filing requires special IRS approval.
• If you plan to bring on a new shareholder or investor, first consider how it could impact your S Corp qualification and get input from your business attorney and CPA.
• Don’t assume you can easily “undo” an S Corp election if you later change your mind. Once elected, S status remains in effect until formally revoked or terminated due to a disqualifying event.

FAQs:

• If my business doesn’t qualify for S Corp status, am I stuck being taxed as a C Corp? No, LLCs that don’t qualify for or want S Corp status can be taxed as a partnership (multi-member) or disregarded entity (single-member).
• What happens if my S Corp accidentally violates one of the qualification rules? It risks losing its S status and reverting to a C Corp. However, relief may be available if the violation was inadvertent and promptly fixed.
• Can my S Corp have different voting and nonvoting shares? Yes, S Corps can have voting and nonvoting shares. As long as both classes have identical rights to profits and liquidation proceeds, it won’t violate the single class of stock rule.
• Who has to sign and consent to the S Corp election? All shareholders must sign Form 2553 consenting to the S election. If one or more don’t sign, the election isn’t valid.
• Is there any limit to how long my business can remain an S Corp? No, as long as you continue to meet the qualification rules, your S election can remain in effect indefinitely unless formally revoked.

Examples:

• Karen’s Florida S Corp enjoys pass-through taxation with no state income tax on her or her company in Florida.
• Mike formed an S Corp in New York, but learned he also needed to file Form CT-6 electing NY S Corp status to have pass-through treatment for state tax purposes.
• Sharon’s S Corp in Massachusetts still owes a state corporate excise tax of 8%, applied to federal taxable income with some adjustments.
• John’s Tennessee S Corp pays the state franchise tax based on the greater of net worth or book value of real or tangible personal property, while an LLC would owe from .25% to .3% of net worth.
• More of Pam’s New York City clients operate as S Corps vs. LLCs. But at a conference in Texas, most business owners she met had chosen to be LLCs.

How to Proceed:

• Consult a business attorney or CPA to understand how your state will tax your S Corp and whether a separate state S election is required.
• Research and compare the state franchise tax calculations and rates for S Corps and LLCs in your state to help guide your entity choice.
• Factor in the full picture of state and federal taxation of S Corps and LLCs when evaluating which entity makes sense for your company.
• Be aware that some states’ tax treatment of S Corps may negate some of the perceived self-employment tax savings compared to an LLC.
• Look for a business attorney or accountant experienced with your state’s particular rules for S Corps and LLCs to advise you.

FAQs:

• Does my business have to register as an S Corp with my state? It depends – most states recognize and follow your federal S election, but a few like New York also require a separate state S election.
• Will my S Corp save me tax at the state level? Not necessarily. While S corps can provide savings on federal self-employment tax, some states still impose entity-level taxes on them.
• How are LLCs taxed in my state? It varies widely. Some states tax them like sole proprietorships/partnerships, others impose entity taxes. Ask your local business attorney or CPA.
• What if I operate in multiple states? You likely need to apportion your S corp or LLC’s income across the states and file a return in each. The rules are complex, so consult a multi-state tax expert.
• Are there S Corp franchise tax savings? It depends on your state’s rules, but in some cases being an S Corp results in a lower franchise tax bill than an LLC would owe.

Questions: LLC vs. S Corp Basics

• • 1. Which of the following is NOT an LLC or S Corp?
    • A) Sole proprietorship
    • B) Partnership
    • C) Corporation
    • D) None of the above
  • 2. Both LLCs and S Corps provide which key tax benefit?
    • A) Pass-through taxation
    • B) Avoiding self-employment tax
    • C) No individual income tax
    • D) Elimination of payroll taxes
  • 3. What’s the default federal tax status of a single-member LLC?
    • A) Sole proprietorship
    • B) Partnership
    • C) S Corporation
    • D) C Corporation
  • 4. Which of the following business types can never be an S Corp?
    • A) Sole proprietorship
    • B) LLC
    • C) C Corporation
    • D) Partnership
  • 5. An LLC with 4 equal owners would receive how many K-1s?
    

Answers: LLC vs. S Corp Basics

• • 1. D) Sole proprietorships, partnerships, and corporations are different types of business entities. LLCs and S Corps are special legal and tax structures.
  • 2. A) Both LLCs and S Corps provide pass-through taxation, where business income flows through to the owners’ personal tax returns.
  • 3. A) A single-member LLC is considered a disregarded entity and taxed like a sole proprietorship by default, unless it elects corporate tax treatment.
  • 4. D) An LLC or C Corp can elect S Corp status if it meets IRS requirements, but a partnership can never be an S Corp.
  • 5. D) A partnership or multi-member LLC will issue a Schedule K-1 to each partner/member to report their share of business income.

Questions: SE Tax & Reasonable Compensation

• • 1. How do LLC members pay self-employment tax?
    • A) On their share of LLC profits
    • B) Only on guaranteed payments
    • C) On distributions
    • D) They’re exempt
  • 2. How can S Corps minimize self-employment tax?
    • A) Paying owners a small salary
    • B) Paying owners entirely in distributions
    • C) Splitting owner pay between salary & distribution
    • D) By electing S Corp status, SE tax is waived
  • 3. What is the key to S Corp reasonable compensation?
    • A) Keeping salary under $10,000/year
    • B) Aligning salary with comparable market wages
    • C) Paying all profits as salary
    • D) Whatever the S Corp owner decides
  • 4. What’s a common red flag for unreasonably low S Corp salary?
    • A) Salary exactly equals distributions
    • B) Salary is under $50,000/year
    • C) Salary is 50% of distributions
    • D) Distributions far exceed salary
  • 5. What’s the IRS penalty for S Corp salaries that are too low?
    • A) Distributions are banned
    • B) Corporation loses S status
    • C) All distributions get reclassified as salary
    • D) Salary must be doubled next year

Answers: SE Tax & Reasonable Compensation

• • 1. A) LLC members pay 15.3% self-employment tax on their share of LLC net income, not on distributions.
  • 2. C) S Corps can minimize SE tax by paying owners a reasonable salary and taking remaining profits as distributions.
  • 3. B) S Corp owner salary should be in line with market rates for similar roles. Salaries that are too low can trigger IRS penalties.
  • 4. D) If S Corp distributions are far greater than owner salary, it suggests wages are unreasonably low to avoid payroll taxes.
  • 5. C) If the IRS deems an S Corp salary too low, it can recharacterize distributions as wages and impose penalties and interest.

Questions: QBI, Distributions & More

• • 1. What does the QBI deduction allow?
    • A) Deducting 20% of business income
    • B) Deducting 20% of business expenses
    • C) A 20% tax credit on business income
    • D) 20% off your tax preparation fees
  • 2. What factors limit the QBI deduction?
    • A) Taxable income thresholds
    • B) Specified Service Trades or Businesses (SSTBs)
    • C) W-2 wages paid by the business
    • D) All of the above
  • 3. How are LLC distributions taxed?
    • A) At the owner’s individual tax rate
    • B) At the dividend tax rate
    • C) Distributions are considered a return of capital
    • D) LLC distributions are tax-free
  • 4. Which of the following must S Corps do before taking distributions?
    • A) Pay owners a reasonable salary
    • B) Withhold payroll taxes on distributions
    • C) File Form 1120S
    • D) Make an S Corp election with the state
  • 5. Which of the following is true about S Corp taxes in most states?
    • A) S Corp status is automatically recognized for state taxes
    • B) S Corps always owe less state tax than LLCs
    • C) All states require a separate S Corp election
    • D) S Corps can’t owe state income tax

Answers: QBI, Distributions & More

• • 1. A) The Qualified Business Income deduction allows eligible taxpayers to deduct up to 20% of business income from an LLC or S corp.
  • 2. D) The QBI deduction phases out at higher incomes, is limited/eliminated for certain professional service businesses, and may be reduced without sufficient W-2 wages or qualified property.
  • 3. C) LLC distributions are typically considered a non-taxable return of capital, as the business income was already taxed on the members’ individual returns.
  • 4. A) Before taking distributions, S Corps must pay owners a reasonable salary and withhold applicable payroll taxes.
  • 5. A) Most states recognize federal S Corp status and will tax the company accordingly, but a few require a separate state S election.