Tax Elections Definition

What are tax elections?

Tax elections are selections regarding tax treatment. In other words, the taxpayer decides how they want the Internal Revenue Service (IRS) and state taxing agency to tax their income. Different tax elections are available for businesses and individuals. In some cases, it’s even possible to make some tax elections and reduce tax liability as a business owner. 

Tax Election Examples

To better understand the meaning of tax elections, it’s helpful to look at some examples. Certain business types can make tax elections. For example, a C corporation can elect to be treated as an S corporation (please see the What is an S Corp? page for more information) for tax purposes. Limited liability companies (LLCs) also have flexibility when it comes to choosing their tax treatment, which is often considered to be a big advantage of the LLC structure. 

Corporations

C corporations are subject to double taxation. This means that the corporation pays the corporate income tax at the business level on net earnings, and then shareholders also pay personal income tax on any dividends they receive from those earnings. This results in the same income being taxed twice. However, a C corporation can make a tax election to be treated as an S corporation, as long as the C corporation meets the IRS’s requirements. S corporations are subject to pass-through taxation. This means that all income passes through to the corporation’s owners, who then report the income on their personal tax returns and pay taxes at their individual tax rates. Since this scenario only results in one level of taxation, the business owner can retain more money to reinvest in the company. 

Limited Liability Companies 

LLCs can be taxed in several different ways. This kind of flexibility is what makes LLCs so attractive to small business owners. By default, the IRS treats single-member LLCs as sole proprietorships and multi-member LLCs as partnerships. The tax treatment for both of these types of LLCs is pass-through taxation. 

An LLC can make an election to be taxed as either a C or an S corporation. At first glance, this approach might sound counterintuitive because it allows for double-taxation on the LLC’s income. However, some successful LLC owners may make this tax election as a strategic decision to avoid falling into a higher tax bracket for personal income taxes. If a business owner is considering this election, it’s wise to consult with an accountant or tax lawyer to calculate which tax status would be most advantageous.

How do small business owners make tax elections?

If a business owner needs to change the tax treatment of their business, they’ll need to file the right form with the IRS to make the election (provided, of course, that the business meets the criteria for that election). For example, if an LLC wanted to elect a different tax status, it would use Form 8832, the Entity Classification Election.

These elections need to be made at both the federal and state levels. It’s wise to check with the Secretary of State, Department of Revenue, or similar state office for any state filing requirements.

Summary

The tax elections definition is quite simple: it’s an election for tax treatment purposes. Before making a tax election, it’s important for business owners to know how the election will impact their business. If in doubt, it’s prudent to get help from a financial professional to get a full and accurate picture of how certain elections will impact the company and its owners. 

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