How to Protect the Tax Benefits of Your Family Business

Written by Haans Mulder, JD, MBA, MST, CFP^® 

You may be one of the many business owners in the State of Michigan and across the county who is a member of an LLC which is taxed as an S corporation.  This can be confusing but stay with me.   What I’m saying is that you may have filed with the particular state agency as an LLC and then your attorney or CPA filed an election for your business to be taxed as an S corporation.

You likely did this because it allows you to minimize employment taxes.  Simply put, the LLC pays you a reasonable salary and then separately distributes the profit to you in a given year.  This planning saves you employment taxes because those taxes are only imposed on your salary and not on the distribution you receive.

As an important side note, if you have an LLC, but haven’t filed an S corporation election, there could be another reason to consider it. Under the new tax act, there’s a 20% tax business deduction for LLCs and other similar business entities.  Being an S corporation might allow you to fully use that 20% deduction and save even more taxes.

If you’ve filed the S selection or are considering it, don’t forget to also update your operating agreement. That’s the agreement you have with the other LLC owners.  Aside from addressing a number of important issues (i.e. how to distribute the profits, what happens if one of the LLC owners passes away, etc.), this agreement will protect the tax benefits of your S corporation.

Let me explain. To receive the tax benefits of an S corporation, you must follow certain rules. If you don’t, you’ll lose that tax status and be taxed twice, once when you make money and a second time when you take it out of the business. Keeping that one level of tax is critical and the operating agreement should have certain provisions to protect that tax status.

If you have any questions regarding this planning, feel free to contact me.