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When starting a business, how do you know what structure is right for you? An LLC or Limited Liability Company is a common choice for companies in NC. With this business structure, you limit your liability if someone should sue your company in the future. However, the S Corporation has benefits that go beyond the abilities of an LLC. So why and how would you convert an LLC to an S Corp?

What is an S Corp?

To form an S-Corp, you first must decide if your structure will be an LLC or a C Corporation. Then, as an LLC or C Corp, you can take an S-election for tax purposes. An S corp is not a business structure; it is a tax designation that you elect for federal taxation purposes. 

Thus, as an LLC business structure in the state of NC, you can choose to be taxed at the federal level as an S-corporation. This tax structure is called an LLC with an S election. 

North Carolina income tax will still treat you as an LLC. NC does not offer an S election filing method for state income tax purposes. The S election is only offered at the federal taxation level.

C Corps That Choose S Election

C Corporations that take on the S election often call themselves S Corps. However, they remain a C corp with a federal S election for tax purposes. Without the S election, a C corp pays income tax and the shareholders pay dividend taxes. This double taxation can contribute to a C Corp choosing to take the S election.

When federally taxed as an S Corp, the company’s income flows through to the shareholders instead of going to the company. The shareholders then pay taxes on the income and dividends on their own tax returns. An S Corp files a tax return but the tax allocations – such as income or gain – are passed directly to the shareholders to report on their individual tax returns. This choice is not suitable for all C Corps. 

Why File an S Election as an LLC?

If you own an LLC, all company profits pass through to your personal tax returns. You then pay personal income tax and self-employment tax on all of the income. This double tax burden may feel heavy to most LLC owners. After all, you are being taxed as an employee despite taking the risks of an owner. 

With an S election, an LLC owner may take a salary as an employee and avoid self-employment taxes on the rest of profits. This strategy can save money in the long run for you and your LLC.

Filing Your S Election 

To create your LLC, you file your Articles of Organization and create your Operating Agreement. Then obtain your EIN number from the IRS and file your S election tax status using Form 2553. This form is also filed and approved by the IRS. 

For taxation purposes, an S Corp does not generally pay taxes on its income. The income of the S Corp flows through to its members or shareholders who then pay taxes on the income. Members or shareholders of a company making an S election typically receive a K-1 to show their share of the company’s income or other tax allocations. 

Benefits of an LLC with an S Election

The exciting thing about being the owner of an LLC taxed as an S Corp is that you can take a salary and avoid self-employment taxes on the profits you receive beyond your salary. 

Normally, an LLC without an S election cannot pay normal wages to owners. An LLC with an S election, however, can pay normal wages and salaries to owners as employees of the LLC. Your salary is “subject to FICA tax and other withholding requirements. But then, it can distribute the remaining net earnings to you and the other owners as passive dividend income, not subject to [self-employment] tax.” (1)

The self-employment tax rate is 15.3% of net earnings. 12.4% of that is Social Security tax, and 2.9% is Medicare tax on net earnings. If you file taxes without the S election, you must pay income and self-employment taxes on all of the profits of the business. With an S election, you may be considered an employee of the business, and employment taxes are only assessed on the money you receive as an employee. The rest of the profits are free from any employment tax. 

We Can Help

At Hill Law, we specialize in business law. That means we focus on all of the factors that go into making the decisions you need to get right to succeed. When we are part of your team, you can rest assured that we think through each tax designation, business structure, and agreement you make. In addition, we help you look at tax consequences, the people involved in your venture, and your expected liabilities when making crucial decisions. Contact us today and let us help you make the decisions to grow as a business in NC successfully.

  1. LLC Electing S Corp Tax Status: An Option You May Not Know You Have