You’ve created an LLC and applied for your E.I.N. number from the IRS. Good! You receive your IRS letter in the mail and it’s got all this information about making a tax election by filing form 2553 or being treated as a disregarded entity. And you’re thinking, “what on Earth does that mean and what do I do?” Here’s how to know what’s best.
Answer all of these questions. If you answer no to any of them, it’s probably best that you do nothing and remain a disregarded entity for tax purposes for now.
- Do you think your business will make at least $30,000 – $40,000 in net profit this tax year? There are tons of tax savings available with the switch to an S-corporation. Unfortunately, many people over-plan for tax savings when they aren’t even sure if they’ll make a profit. I often see someone who is hyper-organized make the election to be treated as an S-corporation only to make a $2,000 profit in year one. This is a waste of filing fees, and a disregarded entity would have been just fine.
- Do you think your new business will continue to operate for at least the next few years? Don’t become an S-corporation for a business you’ll only operate for one or two years. This is, again, a waste of filing fees. You’ll have to file business tax returns for each year you have any income. There may also be tax implications if you transfer business assets to yourself after you’ve depreciated them.
- Will you continue to be the only owner of this entity for the next few years? Having multiple owners can get messy with S-corporations. This is a bit easier to manage with a single-member LLC that becomes a multi-member LLC.
- Are you disciplined enough to open a new business bank account, document your expenses, separate your business from your personal transactions, and register for payroll to pay yourself? If this is your only “no,” consider hiring a good accountant (me) to whip you into S-corp shape. While these tasks can seem daunting at first, they can become easier with good software (Quickbooks Online) and a good teacher (me again).
If you answered yes to all of these questions, an S-corporation may be right for you. If you live in Illinois, contact me and I’ll help you get through the paperwork!