January is the start of tax filing season, and for small businesses, this means sending out their W2s and 1099s and getting all their paperwork and receipts together to send over to their accountant. There is another issue for entrepreneurs to consider at the beginning of each year; which entity structure is best for tax purposes.

A large number of entrepreneurs choose to operate their businesses as either sole proprietorships or limited liability companies (LLCs). Those that have LLCs may choose to file as a Subchapter S corporation (also known as an “S Corp”) for tax purposes. The filing deadline for the previous tax year is March 15 and this can be extended if more time is needed.

Why File as a Subchapter S Corp?

There is one simple reason you may want to consider filing with the IRS as a Subchapter S Corp to legally avoid paying self-employment tax on a large portion of your business income. There is a loophole within the tax code that allows S corps to pay the owner a “reasonable” salary for running the company and take the rest of the profits as a “distributive share.”

Here is an example: assume you have an LLC that earned a profit of $200,000. If you pay yourself the entire $200,000 as salary, you are responsible for income tax (depending on the tax bracket you are in) as well as self-employment tax of 15.3%. This means you would be responsible to pay $30,600 in self-employment tax alone. However, if you elect to file as a Subchapter S Corp, you can pay yourself a salary of say $50,000 and receive the remaining $150,000 as a dividend, which would only be subject to dividend tax. Since you would only pay self-employment tax on just $50,000 in income, your potential savings in this example would be $22,950.

Qualifications to File Subchapter S

Filing as an S Corp for tax purposes when you already have an LLC is relatively simple. All it requires is filing two forms with the IRS; Form 8832 Entity Classification and Form 2553 to be taxed as an S corp. However, there are some restrictions on who can own S corporations:

• S Corps cannot have over 100 shareholders.
• All S Corp shareholders must be U.S. citizens.
• S corporations cannot be subsidiaries of other S corporations, C corporations, LLCs, partnerships and certain types of trusts.

LLCs do not have any of these restrictions.

Which Structure is better for your Business?

S corporations have their advantages, but they are not for everyone. The filing and paperwork to maintain the entity are more complicated and may not be ideal for a part-time entrepreneur or someone just starting out. Before the March 15 deadline to decide, speak with a local accounting firm to find out if an S Corp can benefit your business. One simple call to an accountant could end up yielding significant tax savings if this option is right for you.