Whether you’re an entrepreneur starting a new business, or ready to take the next steps in legitimizing your side hustle, timing is of the essence when you make moves for business growth.
While it’s true that there’s no time like the present, it’s still important to consider the ramifications of forming a limited liability company (LLC) or electing Subchapter S status (S Corp) at the end of the year. Formalizing your business involves navigating various regulatory and tax rules, but the benefits of establishing a formal business structure, even in the last months of the tax year, may outweigh the additional work.
Does timing really matter?
Business doesn’t wait for the start of a new tax year. At year-end, you may need an LLC and tax ID to sign a new contract, open a business bank account to receive client payments or maybe you finally have enough momentum to complete all the administrative tasks you’ve put off all year.
Once you decide to incorporate as a legal corporation, or organize as an LLC, your company is subject to formation fees and filings, regardless of whether you form at the beginning, middle or end of the tax year.
Forming as an LLC or S Corp during any part of the year means taking on additional filing responsibilities. Here’s what you can expect if you opt to establish your business in the last few months of the year:
- Your LLC will be effective on the date your state approves your application. You will pay your states’ LLC formation fee
- Once your LLC is approved, you can apply for an EIN with the IRS
- With your LLC and EIN in hand, you can open a business bank account and start receiving client deposits
- Some states have annual reports or franchise fees for LLCs, even for a partial year. Check your states’ LLC filing requirements and deadlines
Even in a partial tax-year, or “short period,” the tax reporting for a single-member LLC is pretty simple. The IRS considers single-member LLCs a disregarded entity for federal tax purposes, which means the activity is reported on your personal tax return. Keep record of your income and expenses to make tax filing easy, or better yet, invest in a bookkeeping tool or professional service to keep your tax reporting clean.
S Corp status
If you establish an LLC and elect S Corp status, your business will need to file its own tax return with the IRS, even if it’s a short-period tax return.
Changing your tax status near the end of the year will mean additional work, however depending on your earnings, there may still be benefits. Here’s what you can expect if you opt to elect S Corp status in the last few months of the year:
- Your S Corp election is filed on Form 2553 and will be effective on the date listed in box E of the Form 2553
- The initial S Corp tax return will be a short period tax return
- For example, if you formed your LLC on October 1st and elected to be treated as an S Corp as of October 1, your initial S Corp tax return will cover the period October 1st through December 31st. Going forward, your S Corp tax return will cover the full tax year
- Your first S Corp tax return will be due March 15th of the following year
- You’ll be subject to the S Corp compliance requirements: payroll and business tax filing. You’ll also want to ensure you’re regularly keeping up with your bookkeeping and accounting.
- Submit fees and filings for any state-level S Corp franchise fees and any other state or local taxes
Read our full guide to filing your taxes as a short period tax return and how to handle your pre-S Corp income here.
Why you should consider a year-end launch
Before deciding the best time to establish your business structure, you must consider all angles of forming your business at year end.
Year-end tax benefits: Forming an LLC or electing S Corp status for your existing LLC can provide liability protection for the remainder of the year and with the S Corp election, offer some tax benefits. The S Corp structure allows the owner to mitigate self-employment tax on business profit. S Corp owners are paid through W2 salary and business profit distributions and only the W2 salary portion of the owner’s compensation is subject to self-employment tax (both are still subject to income tax). This can contribute to an overall lower tax rate and a reduced tax bill..
New year, fresh start: Forming a new business by December 31st means getting the paperwork out of the way. Rushing to file an Articles of Organization or submitting Form 2553 during the height of tax season can make it challenging to find professional support or can lead to longer processing times. The sooner you handle your paperwork, the sooner you can optimize your tax position.
Legal protection and credibility: A major benefit of being an LLC owner is the business structure offers personal liability protections, which can help you limit your individual risk. The sooner you form an LLC, the sooner your personal assets are protected. Plus, having an LLC lends credibility to your business, instilling trust and confidence in your clients.
More filing requirements: Opting for a new tax classification near the end of the year will result in additional paperwork and complex tax filing requirements. This can include preparing an operating agreement, submitting Articles of Organization or filing the S Corp tax return on Form 1120s.
More complicated taxes: If you spend a portion of the year as a sole proprietor and the remaining months as an S Corp, you must deal with the tax treatment for both your sole proprietorship and S Corp. This makes filing your business and personal tax returns more complex because your business activity will be reported on separate forms. This means you must maintain clean records to accurately split the activity for tax reporting.
Greater regulatory oversight: Depending on your line of business, formalizing your company may lead to additional regulatory requirements that you’ll have to fulfill sooner, like applying for business licenses or insurance. Be sure to review your local state laws to determine your local compliance requirements.
The Bottom Line
Making the decision to form an LLC or S Corp in the last months of the year can feel daunting and complicated for many small business owners, but can position you to set your business up for success.
The key lies in strategic planning, clear understanding of the commitments involved and tapping in help when needed. As you look forward to a new year, setting up your business before the new year can reduce the hassle and stress of tax season and position you to hit the ground running in the near year. If you’re a business-of-one and ready for a clean start to the year, click here to find out how Collective can help.
TJ Porter is a freelance writer based in Boston, Massachusetts. He began covering finance while earning a degree in business at Northeastern University in Boston, Massachusetts and enjoys writing about credit, investing, real estate topics. When he’s not writing, TJ enjoys cooking, sports, and games of the video and board varieties. You can contact him at find more of his work at TJPorterWriting.com