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Started a LLC with my wife - Should we file as S-corp with LLC?

Hi all, 

I got laid off back in March of this year and my wife quit her job end of last year to take a bit of a break from nursing. We live in the state of WA(community property laws apply here). We just formed our first LLC as we have decided to pursue an idea of ours which is patentable. 

We filed with the IRS to get an EIN as a multi-member LLC. I am thinking that we should submit Form 2553 to apply to be taxed as an S-Corp, but I had a couple questions regarding this before I submit this. 

I know as a S-corp, we need to pay "reasonable salary" before we can pay out any dividends, but what if I have zero sales in the first year? What if we have sales but are not profitable? An example I am thinking of is say my business manufactures metal coasters. I sell 10,000 of them in the first year for $10 per coaster for a total of $100,000. 

My cost of materials for each coaster is $5 for a total of $50,000 for all 10k units sold. Say i've bought a machine that automated the manufacturing of these coaster and the machine costed $50,000 but I'm only paying $1500/month for this machine for a total of $18,000/year. This puts me at $68k in costs for the year excluding anything else while giving me a profit of $32k. On the final month of the year I decide that I want to pay off this machine quicker and therefore make a balloon payment of $30,000. In essence my business was a scratch business(or maybe even a negative business).

Now - do I HAVE to pay myself because I put hours into marketing, selling the products, maintaining the machine, etc even though it closed the year out at a loss or break even? 

The business my wife and I are starting will be manufacturing and selling products to retail, but I suspect the first year or so we will have very few to no sales as we work through getting our patent written, generating marketing content, etc. We were fortunate that I was laid off and was able to get a severance package that "should" float our monthly expenses for the next year or so, so paying myself from the business is the last thing I want to do as we have some fairly large capital outlays we are expecting due to the patent application as well as a couple other things.

That brings me to the other side of things - if I only recieved an income for the first 3 months and then received unemployment for a period of time - is it worth switching to an S-corp? I suspect this is something i'll need to talk with a CPA about though.

3 Replies

Started a LLC with my wife - Should we file as S-corp with LLC?

 Just one question before I offer this excellent answer from MichaelL1 below. How are you going to live without income from the S-Corp? You can always pay yourself and have a greater loss on the corporation.


There is no discussion I can find on how often you need to pay yourself.  Everything I find, just says if you are profitable, you must pay yourself a reasonable wage.  So, once a year, or throughout the year will work as long as it is paid, and it is reasonable wage for work preformed. 

"The IRS will not object to the SCorp making zero payments to the owner employee when the business is earning little or no income. But, when the business is making money, it must first pay the owner-employee a reasonable compensation before making any payroll tax-free distributions with any excess funds."


Started a LLC with my wife - Should we file as S-corp with LLC?

The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. However, if cash or property or the right to receive cash and property did go the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate.


See https://www.irs.gov/pub/irs-news/fs-08-25.pdf

Started a LLC with my wife - Should we file as S-corp with LLC?

Further, you should consult with a local tax professional and/or legal counsel prior to making any decisions in this regard.


Also note that since you and your wife own your interests in the LLC as community property in a community property state, you have the option to treat the LLC as a disregarded entity and file a separate Schedule C for each of you (i.e., two Schedules C with your 1040).


See https://www.irs.gov/pub/irs-drop/rp-02-69.pdf

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