Is the S Corp Election Right for Your Small Business?
No one teaches you about tax favorable business strategies in photography school.
As a photographer or a creative, understanding all aspects of owning a small business can be daunting. Choosing the right type of business entity for your small business can be downright confusing.
But setting your company up as a sole proprietorship, LLC, or C corporation can affect your taxes in different ways. And if you are set up as an LLC or C corporation, you have the option to elect S corp tax status.
Yes, things just got even more complicated.
However, I promise it is worth taking the time to ask, “Is the S corp election right for your small business?”
What is an S corp?
S corp is short for “Subchapter S corporation.” It is a special type of tax status that allows business income to pass through to the shareholders before being taxed, which could potentially reduce taxes owed.
An S corp is not a type of legal business entity; it is only a tax status. Your business already needs to be established as an LLC or a C corporation to elect tax treatment as an S corp.
Benefits of Becoming an S Corp for Corporations
Okay, so is the S corp election right for your small business?
If you are a photographer who has set your business up as a corporation, electing S corp status could have some major benefits on your taxes:
S corp status allows the business entity’s profits and losses to flow to the shareholders without first getting taxed at the business level. This allows the business to steer clear of the dreaded double taxation that corporations are typically used to and for the shareholders to be taxed at their individual tax rates. Win win!
Self-employment taxes are only paid for shareholders who are also employees of the corporation.
Dividend income received by shareholders is not subject to self-employment taxes.
A shareholder can receive income both as an employee and as shareholder distributions in order to limit tax liabilities.
Quick caveat on shareholder salaries: the employee salary does need to be “reasonable” for the job. You cannot claim to be an admin assistant at the company you own and pay yourself $1 million bucks a year. Your accountant can help you with the reasonability test for salaries.Ownership transfer is much easier for S corp shareholders than for corporations.
Benefits of Becoming an S Corp for LLCs
As a photographer who owns a small business, it’s probably more likely that you have set up your business as an LLC than as a corporation. Is the S corp election right for your small business then?
Here’s how you may benefit from S corp election if that is the case:
S corp tax status allows the business entity’s income to pass through to its members while also reducing their self-employment tax liabilities.
While LLC members’ individual income tax rate would still apply, they would only need to pay self-employment taxes on income received as wages. (Remember, a reasonable salary needs to be paid.)
The rest of the business income paid out to the members in the form of distributions would not be subject to self-employment taxes. Love to save on those!
Keeping your business as an LLC business entity instead of having to switch to a corporation will allow you to continue to follow less record-keeping and formal meeting requirements. You get the best of both worlds!
So what are the drawbacks?
There are many upsides to electing S corp status for your creative small business. However, a couple drawbacks need to be considered before moving forward:
Employee-shareholders must receive a reasonable salary, even if the business entity is not profitable. This could create a cash-flow problem for young businesses.
For the most part, S corps cannot be owned by unrelated LLCs, corporations, or trusts.
S corps are limited to 100 shareholders.
All shareholders must legally reside in the United States.
Every shareholder must agree to the business entity electing S corp status.
Sole proprietors are not able to file S corp elections. They would first need to become an LLC or a C corporation.
Becoming an S corp is a lengthy process - no matter your business structure.
Is the S Corp Election Right for Your Small Business?
Your head may be spinning right now as you try to determine if the S corp election is right for your small business. Converting your LLC or your corporation to an S corp could save you a significant amount in taxes by splitting business income into salary and distributions, while keeping your record-keeping light.
However, timing is a key factor in choosing the S corp election. Elections must be made by March 15th of the affected tax year; otherwise, the election will not apply until the following year.
Your business also needs to have the income to carry your shareholders’ salaries. This is an important calculation that you need to understand before deciding if the S corp election is right for your small business.
I would love to talk to you more about what business entity and tax structure may be most advantageous for you as a photographer or a creative. I can connect you with CPAs and business attorneys who can make sure you as a photographer or creative are legally and tax compliant. And I can certainly answer that question, “Is the S corp election right for your small business?”
