A retroactive S-Corporation election is an election to tax your entity (LLC or C-Corporation) as an S-Corporation retroactively as of a certain date. The retroactive election is allowed as a safe habor under Rev. Proc. 2013-30.Why it is beneficial
S-Corporations allow you to reduce FICA tax exposure. Without an S-Corporation, all of your net business income is subject to FICA taxes. This generally results in paying a 15.3% tax in addition to your marginal tax rate.
As an S-Corporation owner, you will pay yourself a salary and report the wages on Form W-2. The salary will generally be a lower amount than total net business income. The amount of your business income that is not being paid out in the form of W-2 wages is not subject to FICA taxes. Thus, you create tax savings by shielding a portion of your overall business income from FICA taxes.Who should use an S-Corporation election
Business owners who are netting at least $40,000 in business income should consider an S-Corporation election.
If you run your business out of your personal name or an LLC not taxed as an S-Corporation, FICA taxes on $40,000 of net business income will be $6,120 ($40,000 x 15.3%). However if you were operating out of an S-Corporation, you may be able to substantiate paying yourself 60% of the profits, or $24,000, as W-2 wages. This will leave you with $16,000 in remaining business profits. Since $24,000 is being paid in W-2 wages, and $16,000 is passing through as your remaining business profits, your FICA taxes are assessed only on the W-2 wages and will total $3,672 ($24,000 x 15.3%).
In the above example, without an S-Corporation, FICA taxes totaled $6,120. With an S-Corporation, and paying W-2 wages equal to 60% of the net business profits, FICA taxes totaled $3,672. Electing to be treated as an S-Corporation in this example saves you $2,449 in FICA taxes.When to use a Retroactive S-Corporation Election
You want to use a retroactive S-Corporation election as a timing mechanism. Under Rev. Proc. 2013-30, you are allowed to retroactively elect to be treated as an S-Corporation for up to 3 years and 75 days after the date in which you meant to be taxed as an S-Corporation as long as you have reasonable cause to do so.
In our experience, the IRS liberally applies “reasonable cause” and almost any excuse seems to work to grant the retroactive election. This could change in the future.