Learn all the essentials to making an LLC S corp election.
If you’re an LLC, electing S corp status might be on your business’s horizon. But is it time to elect S corp status? How do you file for S corp status? Is it better to be an S corp or a standard LLC? In this guide, we’ll cover all the essentials to becoming an LLC with S corp election.
Many limited liability companies (LLCs) — but not all — can elect S corp status. They have to meet the IRS criteria, though. To qualify, the LLC must have 100 members or fewer (called “eligible shareholders”), only one class of members, and members can only be individuals, certain trusts, or estates. Other entities and non-resident aliens can’t be members of the LLC. There are also a couple entity types, such as insurance agencies or financial institutions, that can’t qualify.
There’s one very crucial distinction we should make you aware of when comparing LLCs and S corps. Technically, it’s not even fair to “compare” them because they’re two distinct categories: an LLC is a legal entity type and an S corporation is a tax classification that different business entities can opt into.
That said, a standard LLC and an LLC taxed like an S corp do have some key differences. The most important one is the tax burden of the members. In an LLC with a default classification for taxes, the members receive distributions from the business income as their pay, which is taxable income. They’ll owe income taxes and self-employment taxes on the entire distribution they receive.
In contrast, members of an S corp can be treated as employees of the entity. They can pay themselves a reasonable salary and then give themselves any remaining profits through a distribution (usually in accordance with their ownership percentage). This structure gives a break on self-employment taxes because those taxes will only be levied on the salary income only. Each distribution is treated like a dividend for tax purposes. Dividend income isn’t considered to be self-employment income. Of course, this is only for self-employment taxes; LLC members still must pay income and other applicable taxes on their dividends.
There isn’t a one-size-fits-all answer for when you should elect S corp status, but there are a few criteria that any business owner should consider:
While those aren’t the only reasons you might be ready for an S corporation, they’re pretty good indicators. If you’re unsure if becoming an S corporation owner will actually save you money on taxes, we recommend consulting with a licensed accountant or tax attorney. They’ll walk you through the specifics of how the status will affect your wages, your distributions, and any other tax benefits.
S corporation status comes with some notable perks, especially tax advantages. One of the biggest potential benefits is that the members who are running the LLC can partially pay themselves like employees, greatly reducing their self-employment tax burden. S corporations are also taxed like partnerships (or sole proprietors for single-member LLCs), which means they’re subject to pass-through taxation for federal income tax purposes. The LLC itself doesn’t pay taxes; the members do by reporting their LLC income on their personal income tax returns. This approach also avoids the double-taxation of a regular corporation, and in some cases avoids higher corporate tax rates.
As an added plus, electing S corporation status doesn’t change the day-to-day way a corporation is run. The entity itself is still more flexible than a corporation. Plus, all the members still get personal liability protection because electing S corp status doesn’t affect liability or the company’s structure, only taxes. In a way, an S corporation tax election gives an LLC the best of both worlds.
There are a few downsides to electing S corp status, though. For one, you can only have a limited number of members. And your members can only be individual residents of the U.S. (with a few exceptions). Those requirements somewhat limit the investments you can get.
More importantly, S corporations are much more likely to get audited because the IRS monitors them closely so the potential tax benefits aren’t abused. For a compliant LLC, this isn’t a huge issue. But audits are stressful for anyone. And if the LLC hasn’t adhered to the IRS’s corporation rules for taxes, an audit can spell disaster.
One thing the IRS particularly pays attention to is whether the LLC members in an S corp are paying themselves a “reasonable salary” as employees of the LLC. Otherwise, they could pay themselves an annual salary of $1 and avoid contributing anything to Social Security and Medicare. The IRS doesn’t give a crystal-clear definition of what it considers a “reasonable” salary to be, but, generally speaking, it’s something similar to what others in the same field are earning for the same work.
Electing S corp status as an LLC is actually relatively simple. All it really entails is filing one or two forms. If you’re within 75 days of forming your LLC, all you have to do is submit IRS Form 2553, Election by a Small Business Corporation. If more time has passed, you’ll file that form and IRS Form 8832, Entity Classification Election, at the same time. This second form essentially informs the IRS that you’re opting in for a type of corporation taxation.
You should also check with your state agencies to find out if there are any additional requirements at the state level. It’s also a good idea to add this status to your operating agreement.
Electing S corporation status doesn’t have to feel overwhelming — ZenBusiness has your back. Whether you need help forming your LLC, managing your LLC’s finances with our Money app, or staying compliant every year, we can support you every step of the way.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Typically, LLCs elect S corp status to get a break on their tax liability for self-employment taxes without losing the flexibility of running an LLC.
It depends on the LLC. For an LLC that’s well-established with good bookkeeping practices and perfect compliance, electing S corporation status may be perfect. But if an LLC’s members don’t enjoy religious bookkeeping or they won’t be able to hire someone to do it for them, or if the LLC isn’t making enough money to pay the members a “reasonable” salary,” it may not be a good fit.
If you’ve been an LLC for less than 75 days, all you have to do is file IRS Form 2553. But if you’ve been in business longer, you’ll need to file both Form 2553 and Form 8832.
The IRS doesn’t maintain a searchable database that you can use to look up an LLC’s tax status. Some businesses make this info readily available to the public, but not all.
Yes. While the IRS has a maximum limit for the number of members an S corporation can have, there is no minimum. So an LLC with a single owner can elect this tax classification as long as they qualify as an eligible entity.
An LLC is taxed as a pass-through entity because while it’s considered a separate entity from its owners for liability purposes, for taxes the LLC is indistinguishable from its owners. So, the members pay taxes by reporting their share of the business profits on their personal tax returns, and the business itself doesn’t pay federal income taxes on the profits. This differs from a typical corporation (a C corporation), in which profits are taxed at both the business and individual owner levels (which is known as “double taxation”).
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