Many real estate professionals choose to designate their LLCs as an S corporation, known as an S corp, for tax purposes. While this move can lead to significant tax benefits, it also comes with an added level of responsibility. Here's what you should consider before changing your tax designation. Armed with this knowledge, you should be able to make the best decision for you and your business.
Consider the tax benefits
The main reason why someone might choose to structure their real estate LLC as an S corp is for the tax benefits. Once you elect an S-corp tax status, the income your LLC makes will be treated differently, which can lead to significant tax savings.
In an LLC, any income is passed through to the owners, who pay tax on it as self-employment income. The self-employment tax is currently 15.3%. As a single-member LLC, you would be responsible for paying the self-employment tax on your entire income in addition to paying income tax.
However, as an S corp, your income would be taxed differently. In this case, you would be responsible for paying yourself a reasonable salary. While you would still have to pay the self-employment tax on any amount you earned in salary, any profit above your salary amount could be distributed to you as dividends, which would be taxed at a lower rate.
An S corp tax benefit example
Let's say you made $100,000 in net income this year. With those numbers, if you were being taxed as a single-member LLC, you would be responsible for paying $15,300 in self-employment tax, in addition to the amount of income tax that you owe.
In contrast, let's say you earned the same amount while electing to be taxed as an S corporation and paying yourself a salary of $50,000. in this case, you would only be responsible for paying the self-employment tax on $50,000, and the rest would be taxed as ordinary income, which would mean you only pay $7,650 toward the self-employment tax.
All told, that's a tax savings of $7,650 that goes back into your pocket.
Check your eligibility
That said, tax benefits aside, not all LLCs are eligible to take on an S-corp tax status. For example, single-member LLCs are always viewed as sole proprietorships for tax purposes. In addition, S corporations must include no more than 100 owners, all of whom are U.S. residents. Plus, they can only have a single class of shareholders.
While these limitations may not be a big deal for everyone, if you envision yourself going after funding from investors in the future, being taxed as an S corp may put you at a disadvantage.
Weigh the compliance requirements
Finally, being designated as an S corp comes with additional compliance requirements. S corps must hold both initial and annual director and shareholder meetings, adopt and maintain bylaws, issue stock to all shareholders, and record all stock transfers. Additionally, many states require you file your annual report, which usually comes with a corresponding deadline and fee.
If you feel you have the time and business savvy to keep up with these requirements, an S corp may be a good option for you. However, if you don't want to have to worry about meeting these requirements annually, it may make more sense to stick with a traditional LLC,
The bottom line
At the end of the day, choosing an S-corp tax status is a big decision that comes with added responsibilities. As the owner of your own real estate business, it's up to you to weigh the advantages and disadvantages of electing to be taxed as an S corp to determine if this move makes sense for you. That said, if you need help sorting things out, it's always a good idea to talk to a financial advisor or tax professional before making any final decisions.