LLC taxed as S Corp-I screwed up didnt I?

pgmrmike · Nov 24, 2021

When I started my LLC ( was SP ) in 2018 I chose to be taxed as S Corp. I didnt do a lot of research ( clue number 1 ), but a former employer ( very successful in business ) always extolled the virtues of chosing S corp over C corp. Made sense to me.

It was never a problem until this year. We have done very well this year ( after yrs of tough times-all oil business related work ) and finally made some money. I see the corporate tax rate is 21%, ( I believe it was 35% so seemed to make sense at the time )and this year my tax rate will be the max ( I believe 37% ) since all the company income passes through to me.

Clearly I am uneducated, but did I just screw myself out of 16%?

Not sure what my options are here

drcoelho · Nov 24, 2021

The reason S corp treatment is preferred over C corp, is that you don't get hit with double taxation. With a C corp, the C corp pays taxes on income, and then when you pull cash out of the C corp (e.g. salary, shareholder distribution,etc) you get taxed AGAIN as personal income, thus in most cases you are better off with S corp, which only taxes you once on the income.

wheelieking71 · Nov 24, 2021

pgmrmike said:
When I started my LLC ( was SP ) in 2018 I chose to be taxed as S Corp. I didnt do a lot of research ( clue number 1 ), but a former employer ( very successful in business ) always extolled the virtues of chosing S corp over C corp. Made sense to me.

It was never a problem until this year. We have done very well this year ( after yrs of tough times-all oil business related work ) and finally made some money. I see the corporate tax rate is 21%, ( I believe it was 35% so seemed to make sense at the time )and this year my tax rate will be the max ( I believe 37% ) since all the company income passes through to me.

Clearly I am uneducated, but did I just screw myself out of 16%?

Not sure what my options are here

In red ^^^^^^

Do you not take a pay-check? The way that reads to me is: all the money goes to you as an individual. If that is the case? You you screwed up.

I don't claim to understand this fully. I barely understand it when my accountant lays it out right in front of me on the white-board.
But I do know this: when filing as an S Corp, you need to pay yourself "reasonable compensation".
Meaning, you draw a pay check, and the rest of the $$$ stays in the business account until taxes have been handled.

I know I stand to make considerably less in 2022 than I have since I started making enough that it made sense to file S Corp.
And he plans to switch me back to an LLC. But, he just told me once you do that, you are stuck there for 5 years.
He also told me there are ways around that (start a new LLC, and switch it to S Corp basically).

Like I said, I'm definitely not the guy to give tax advice. But, you should have been taking a pay check. I know that for sure.

Booze Daily · Nov 24, 2021

S Corp income passes thru to you as ordinary income. Are you saying you made so much profit it put your personal income into a 37% bracket? (Edit.. just looked it up, your personal income needs to be $523600 to be in the 37% bracket. If so, congrats. That’s pretty good for a 3 yr old company)

Well, you could spend some of it. Stock up on tooling, make some repairs, maybe a new pc of equipment that you could Sect 179 for full depreciation this tax year.

I’m not an expert. Talk to an accountant.

drcoelho · Nov 24, 2021

wheelieking71 said:
In red ^^^^^^

Do you not take a pay-check? The way that reads to me is: all the money goes to you as an individual. If that is the case? You you screwed up.

I don't claim to understand this fully. I barely understand it when my accountant lays it out right in front of me on the white-board.
But I do know this: when filing as an S Corp, you need to pay yourself "reasonable compensation".
Meaning, you draw a pay check, and the rest of the $$$ stays in the business account until taxes have been handled.

I know I stand to make considerably less in 2022 than I have since I started making enough that it made sense to file S Corp.
And he plans to switch me back to an LLC. But, he just told me once you do that, you are stuck there for 5 years.
He also told me there are ways around that (start a new LLC, and switch it to S Corp basically).

Like I said, I'm definitely not the guy to give tax advice. But, you should have been taking a pay check. I know that for sure.

It is correct, that you should pass through your S corp income to your personal return in two different forms: a) a "fair" salary, and b) the rest is shareholder distribution. The reason for the salary component is the government wants you to pay employment taxes. The exact amount of "fair" is open to debate, one should use the lowest value that as justified for someone in a similar position to yourself.

Regarding leaving the income in the business, NO, this not how an S Corp works. With an S Corp, you pass along ALL profits from business every year onto your personal tax return. The S corp pays no income taxes. This is the advantage of an S Corp, you only pay taxes once, the S corp pays no income tax, and you pay all the income tax on your personal tax return.

Despite you have had a good year, and your tax bracket being bumped up, you are most certainly still better off having an S corp as again, you don't get the double taxation hit.

Also, it is correct that once you elect to S corp status, you are stuck with this for 5 years before you can revert back to C corp.

Bondo · Nov 24, 2021

Why are you asking us about IRS stuff, I'm sure everyone has screwed up as well and the only real answer is to talk to your accountant.

Sent from my SM-G960U using Tapatalk

Booze Daily · Nov 24, 2021

I just offered some potential options above. What I personally do is leave 10% profit in the company and give anything above that to myself as a year end bonus. With proper payroll taxes withheld.

So now I’ve payed all taxes due except the 10% that flows thru. Makes it easier on the wallet. Now I can pay any additional 1040 due out of the bonus.

Modelman · Nov 24, 2021

Booze Daily said:
S Corp income passes thru to you as ordinary income. Are you saying you made so much profit it put your personal income into a 37% bracket? (Edit.. just looked it up, your personal income needs to be $523600 to be in the 37% bracket. If so, congrats. That’s pretty good for a 3 yr old company)

Well, you could spend some of it. Stock up on tooling, make some repairs, maybe a new pc of equipment that you could Sect 179 for full depreciation this tax year.

I’m not an expert. Talk to an accountant.

^^^^^
This. Buy things to expand the business and write off this year. The Section 179 deduction is your friend. If your accountant hasn't pointed that out, get a new accountant.

Also, there is a misconception about marginal tax rates... often called "last dollar" rates. If your taxable income was $523,601 This year you will only pay 37% on one dollar. What you actually pay will be considerably less. Your accountant should have explained THAT to you, also.

Dennis

pgmrmike · Nov 24, 2021

I do get a salary, but as others have said, the remainder passes through to me. I did apparently over estimate my tax rate, certainly did not clear $500k. I did buy a couple of machines ( and have every year for several years ) and get the sec 179.

Also, this is year 8 in business, I started out as SP, but went to LLC when I started hiring people.

pgmrmike · Nov 24, 2021

There is always the battle, in my mind, whether to buy eqpt or pay more taxes. Of course, you save the tax money but at some point you kinda wanna keep some yourself.....but then you are basically punished.

Also, I recently started paying myself rent to have more income thats not subject to payroll tax( I own the building personally ) and starting to wonder if thats pointless since all the income passes to me anyway.

And, quite frankly, my accountant doesnt seem to be very good. She does what I tell her to do, but doesnt seem to have good answers to questions about which is the best way to handle things. I basically have to just tell her what I want to do, but clearly I dont know what Im doing....

Modelman · Nov 24, 2021

Also, what makes you think the C Corp. tax rate is going to stay at 21%, especially with the current administration spending money like it's going out of style? The corporate tax rate is very likely to return to 35%, or higher, in the next couple of years. That's before you get taxed personally on any distributions you take beyond salary.

Dennis

Booze Daily · Nov 24, 2021

Ha. I don’t think my accountant is all that great either. I’ve had to point out things that I think he should have known. My best results came from an accountant/financial planner. But that was kinda pricey.

CarbideBob · Nov 24, 2021

Not sure why you think you screwed up.
If a C it would have been taxed but not yet your money. It is the corp's which is a person upon itself.
Then to you get your hands on it you would pay yourself later and get taxed again. The double tax trap.
In a C one would take an end of year bonus to reduce the corp profit to just above zero so no taxes there but it becomes taxed payroll so just like a S.
There is a limit to this trick, "excessive compensation".
If you did not want the money to spend but wanted to leave it in the company for expansion then the C route better.
It is complicated and that is why accountants and tax lawyers get paid. Like any employee they should pay for themselves and be an actual profit center.
Bob

LOTT · Nov 24, 2021

To my limited understanding an LLC taxed as an S Corp is the best setup. Couple thoughts-

-Find an accountant that will call you up and chew you out if you deserve it (I have deserved it a couple times). Just going off statistics, a guy past middle age that owns a successful accounting practice will be your best bet.

-Is the business paying for everything it reasonably can? Beyond tools, this is things like work clothes and boots, your cell phone and monthly service, all the milage you can claim, etc. It's not going to burn $50k, but it doesn't hurt.

-Does your health insurance quality for an HSA? That comes right off the top, and you might actually get to spend it (unless the accident is fatal, then your own your own...).

-Can you stock up on material? That's just kicking the tax down the road, but I'd rather kick it than pay it. And maybe next year will be less profitable. A swiss shop down the road did that at the end of 2020, and incidently avoided a bunch of material shortages.

Bill D · Nov 26, 2021

Talk to a good accountant. I would think you can send in amemded returns for some years past and change how the taxes and expenses were figured, deductions etc.
Bill D

drcoelho · Nov 26, 2021

Summary of your options:

- keep the business as an S corp, then you flow all the income onto your personal tax return, and pay taxes per your in two parts: a) the portion identified as salary also must pay employment taxes, b) the portion identified as shareholder distribution just flows onto your return. Both are taxed at your personal tax rates. As stated, the advantage of this is no double taxation. In general, you can somewhat control how much income flows out of the business by buying equipment and using Section 179 expensing. One additional benefit is if you have income other than your business, and your business loses money, you can use S corp losses against other income.
- change business to C corp. Now your income is locked into your business, not accessible without double taxation, but you could theoretically keep your personal income quite low. And if you mostly use up your profits in the business to expand and buy new equipment using Section 179, you can control the profits of the business and therefore control how much tax you pay.

The tradeoffs really relate to how important it is for you to have personal access to the profits of the company during the current year, e.g. do you need the income to feed your lifestyle. Most folks use subchapter S because it is a very attractive scheme due to no double taxation. But, some folks might find the C corp approach appealing if they don't need the cash from the business and they want to minimize their personal income taxes, as generally, small business tax rate will be lower than personal tax rates in most states.

gbent · Nov 26, 2021

pgmrmike said:
And, quite frankly, my accountant doesnt seem to be very good. She does what I tell her to do, but doesnt seem to have good answers to questions about which is the best way to handle things. I basically have to just tell her what I want to do, but clearly I dont know what Im doing....

Here is your problem. You need a new accountant. It will be an accounting firm, not a sole proprietor. Depending on how much you need them to do, the cost could be in the neighborhood of 1/2% of gross. When you get the bill, you should feel it is some of the best money you ever spent.

Big B · Nov 26, 2021

pgmrmike said:
"Also, I recently started paying myself rent to have more income thats not subject to payroll tax( I own the building personally ) and starting to wonder if thats pointless since all the income passes to me anyway".

You aren't paying social security taxes on the money that you get in rent from you building so that saves you around 15%. I think you need a new accountant, like yesterday.

idacal · Dec 1, 2021

there is nothing wrong with having couple of accountants do your taxes when I first started I had one the thought he worked for the irs, not me, Litterly what do you have in the bank and add 20 grand to it and that's what you owe. but I had been with him since my first tax returns as a teenager, finally fired him and hired another saved thousands a year. but the fact of the matter is if you make money your going to pay taxes. if your making profit of couple hundred grand your tax bill should be 50 or so thousand dollars. but profit is what's in the bank, boats, guns, cash, personal cars for the wife, personal expenditures, huge house payments. not what came in over the material bill. but get a better accountant its still painful but its worth going to work at least.

LLC taxed as S Corp-I screwed up didnt I?

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