Many of our clients are still confused when they ask if they have filed a tax election for their company or if their LLCs are taxed as Disregarded Entity, S or C Corporation? In general, U.S. business owners can elect to treat their LLCs as corporations or make other tax elections as part of their tax planning.
A tax election is a strategic decision to apply a specific tax treatment to a particular situation or transaction. The outcome directly impacts how income, deductions, gains, or losses are reported for tax purposes. Tax elections are very common because they offer great planning opportunities, allowing taxpayers to minimize tax liability, defer taxes, or align tax treatment with their financial or business goals; for instance, here are some examples of Tax Elections:
- S Corporation Election (U.S.): Eligible corporations or LLCs can choose S Corporation status, allowing income, deductions, and credits to flow through to shareholders, avoiding double taxation.
- Section 179 Deduction (U.S.): Businesses can elect to deduct the full cost of qualifying property in the year it’s placed in service.
- Capital vs. Ordinary Expense (U.S.): Taxpayers can decide how to treat repairs to business property, choosing between capitalizing the cost or treating it as an ordinary expense.
- Foreign Earned Income Exclusion (U.S.): U.S. citizens or resident aliens abroad can elect to exclude a certain amount of foreign-earned income from U.S. taxable income.
Before making any election, it is crucial to be well-informed and consult with your accountant or attorney to make the right choices.
For instance, a business owner will want to make an S Corporation election because his business might be paying a lot of self-employment taxes. Generally, entrepreneurs start a business by creating an LLC. With the creation of the LLC, they want to achieve liability protection, but they are not seeking any particular tax treatment. In fact, business owners are not so concerned about taxes when the business starts because they are generally incurring losses. The LLCs are flow-through entities, with income and deductions flowing through to individual tax returns. However, as the business grows, the business owners realize that they are paying a huge amount of self-employment taxes. At this point, generally accountants advise their clients to consider making an S-Election by filing IRS Form 2553, “Election by a Small Business Corporation.” After the S-Election is complete, the business owners will have to comply with certain obligations, such paying themselves a reasonable salary subject to Social Security and Medicare taxes.
A tax election is very important so do not make it without consulting with tax professionals. If you need assistance, book your 15-minute call here.
