Tax Saving Tip: Should You Convert Your LLC or Partnership to an S-Corp?

Hi. My name’s Greg Reed, and I’m the Head of Tax at SmartBooks. Today, I want to discuss whether it might make sense for your business to convert your LLC to an S-Corp, a move that could lead to significant tax savings. This strategy isn’t right for everyone, but for many small business owners, converting from an LLC or Partnership to an S-Corp can reduce tax liability, especially self-employment tax.

Why Convert LLC to S-Corp?

The main reason to convert an LLC to an S-Corp is the self-employment tax. If you operate as an LLC or Partnership, all your net income passes through to your tax return, and all of it is subject to the 15.3% self-employment tax in addition to standard income tax.

S-Corps are treated differently. While income still passes through to the owner’s return, that pass-through income is not subject to self-employment tax. This can lead to significant tax savings, especially as your business grows.

How S-Corp Compensation Works

There’s a catch: as an S-Corp owner, you must pay yourself a reasonable salary. The IRS requires this to prevent abuse of the S-Corp structure. However, once your salary is set, the remaining income can be taken as owner distributions, which are not subject to self-employment tax.

For example, if you pay yourself a reasonable salary and take additional distributions from your S-Corp, you could save 15.3% in taxes on that distribution income. That’s real money back in your pocket.

When Should You Convert?

A good rule of thumb: if your business is netting at least $40,000 to $50,000 per year, it might be time to look into an S-Corp election. At this income level, the tax savings from the conversion typically outweigh the extra administrative work and payroll obligations.

If you’d like help deciding whether this change is right for your situation, contact us at SmartBooks. We’ll walk you through the financial pros and cons based on your unique business model.