If you operate a pass-through business entity such as an S corporation or limited liability company, the recent changes to the US tax code may be of interest. In fact, now is a great time to get in touch with your tax preparer or accountant to ask them to help you determine whether (at least tax-wise) it might make sense to change your entity type.
DLO was originally formed as an LLC, and a few years into our existence elected S corporation status. We had a few reasons for thinking about changing our tax status toward the end of 2017, so when the tax code changed, we knew it was time to consult our advisors. Sure enough, all of them agreed it would be beneficial for us to un-elect being taxed as an S corporation and to return to the default taxation for LLCs, being taxed as a partnership.
Many businesses that originally organized as LLCs and at some point elected S corp tax treatment may find themselves in the same position as DLO. If you think you might fall into this category (or know that you do after consulting with your tax advisors) what needs to happen to make the switch? Below we’ve listed the things we had to do, with a bit of information about each step.
- Determine Eligibility. Once you elect S corporation tax treatment for a business, the IRS generally requires that you not switch your tax treatment again for 5 years. So, if you made an S election in or before January 2013, you should be eligible, but if you made it more recently, you may have to wait.
- Document the Decision. Depending on whether your LLC is member-managed or manager-managed, observe whatever method for decision making your company requires and document that the members (or managers) voted to revoke the S corporation election.
- Communicate with IRS. Once you’ve determined you are eligible to switch your tax classification and have documented the company decision, you will need to communicate this election to the IRS (see Form 8832). Note that in addition to filing this form, you’ll need to include a copy of it with your next tax return, so save a copy for next April.
- Inform Payroll Provider. The best time to make this switch is before you run any payrolls for the year in which you will be un-electing. If that’s not the case, you definitely want to ask your payroll and tax providers what to do, and either way you want to let your payroll service know ASAP that you are no longer an S corp tax-wise so they stop withholding tax amounts from any owner payments.
- Inform Benefits Provider(s). If your company has a 401K/other retirement account or provides health insurance or any other benefits, you should also inform them as soon as you decide to un-elect S status. It may not effect certain benefits, but better to be safe than sorry when informing folks about the change.
- Determine (and Document) Owner Draws. Under the most recent tax law changes, certain owner payments (referred to as Qualified Business Income in the statute) may not qualify for the new 20% tax deduction. Depending on how you make payments to owners, they may (or may not) be classified as QBI. Talk with your tax preparer about how to determine what each owner will take from the company moving forward, and if avoiding QBI is important to you, ask what options may be available for determining owner draws to minimize QBI.
- Prepare to Pay Estimated Taxes. The biggest change when moving from an S corporation to an LLC tax-wise is the need to make quarterly estimated tax payments (because taxes will no longer be withheld from your paycheck). The IRS does provide forms to determine how much your quarterly payments should be to avoid penalties, but these forms have not, as of the date of this blog post, been updated for the new tax law. So another consultation with your tax advisor is probably a good idea here as well.
The list may seem long, but this doesn’t have to be a confusing process so long as you communicate your priorities to your tax advisors and take whatever steps are required without delay so as to avoid losing the option to change your status this year.
Looking for more information about the new tax law changes and your business? We wrote more about the topic in this previous blog.