You’ve got questions and we’ve got answers! We know some terminology can be confusing. We’re here to clear the air and give you a complete understanding of what it means to be both an LLC and and S-Corporation.
Q: Can a limited liability company (LLC) elect to be taxed as an S-Corporation?
A: Yes, an LLC can choose to be taxed as an S-Corporation by filing the appropriate forms with the Internal Revenue Service (IRS). This election does not change the entity’s legal structure under state law—it remains an LLC—but it does alter how the business is treated for federal income tax purposes.
Q: What is the benefit of electing S-Corp taxation for an LLC?
A: The primary benefit is the potential reduction in self-employment taxes. In a standard LLC, all business income is typically subject to self-employment tax. However, with S-Corp taxation, the owner can receive a portion of the income as a salary (which is subject to employment taxes) and the rest as a distribution (which is not), potentially lowering overall tax liability.
Q: Does electing S-Corp status make the LLC a corporation?
A: No, electing to be taxed as an S-Corp does not convert the LLC into a corporation. It is still legally an LLC and governed by state LLC statutes. The S-Corp election affects only how the entity is taxed at the federal level.
Q: How does an LLC make the election to be taxed as an S-Corp?
A: The LLC must file Form 2553 with the IRS, which is the election by a small business corporation. The form must be signed by all shareholders (or members, in the case of an LLC) and submitted within the required time frame, usually within 75 days of the beginning of the tax year for which the election is to take effect.
Q: What are the requirements to qualify for S-Corp taxation?
A: The LLC must meet several eligibility criteria: it must be a domestic entity, have no more than 100 shareholders, have only allowable shareholders (which generally means U.S. individuals, certain trusts, and estates), and it must have only one class of stock. These rules are strictly enforced, and non-compliance can result in the loss of S-Corp status.
Q: Can a multi-member LLC elect S-Corp taxation?
A: Yes, a multi-member LLC can make the election to be taxed as an S-Corp as long as all members are eligible shareholders. The LLC must also comply with the one-class-of-stock requirement, which means profit and loss distributions must be proportionate to ownership interests.
Q: Can a single-member LLC elect to be taxed as an S-Corp?
A: Absolutely. A single-member LLC can elect S-Corp status provided the sole member is an eligible shareholder. The key consideration is whether the tax benefits outweigh the increased administrative obligations.
Q: What are the tax implications of this election?
A: An LLC taxed as an S-Corp is treated as a pass-through entity, meaning that the income is reported on the owners’ individual tax returns, not at the corporate level. However, unlike a standard LLC, the owner must be paid a reasonable salary, and payroll taxes must be withheld and paid. The remaining profits can be distributed without being subject to self-employment tax.
Q: What constitutes a “reasonable salary”?
A: The IRS requires that owners who work in the business receive a salary that reflects the market rate for the services they perform. This is a highly scrutinized area, and underpaying oneself can result in penalties and the reclassification of distributions as wages.
Q: Does electing S-Corp taxation add complexity?
A: Yes, it does introduce additional requirements. The LLC must run payroll, file quarterly payroll tax returns, issue W-2s to owner-employees, and potentially maintain corporate-like formalities to support the election. This added complexity often requires help from a CPA or payroll provider.
Q: Can the S-Corp election be revoked?
A: Yes, an LLC can revoke its S-Corp election by filing a revocation statement with the IRS. This can be done voluntarily if the owners decide the structure is no longer beneficial, or involuntarily if the LLC fails to meet the ongoing requirements.
Q: Are there restrictions on how profits can be allocated in an LLC taxed as an S-Corp?
A: Yes. Because the IRS views an S-Corp as having only one class of stock, profit distributions must be made in proportion to ownership interests. Unlike in a traditional LLC where members can agree to special allocations, that flexibility is limited under S-Corp rules.
Q: How does this affect the LLC’s operating agreement?
A: It’s important to review and potentially revise the operating agreement to ensure it aligns with the S-Corp election. Provisions related to distributions, compensation, and member roles should be carefully drafted to comply with IRS guidelines and avoid inadvertent termination of the S-Corp status.
Q: Do state tax laws align with federal S-Corp treatment?
A: Not always. State tax treatment of LLCs and S-Corps varies. Some states recognize the S-Corp election and tax accordingly, while others do not. Additionally, some states impose separate franchise or gross receipts taxes. It’s important to evaluate the impact at both the federal and state levels.
Q: Should every profitable LLC elect to be taxed as an S-Corp?
A: No. While S-Corp taxation can offer significant savings for some businesses, especially those with consistent profits and active owners, it’s not the best fit for everyone. Businesses with lower profits, passive owners, or those unable to manage the added complexity may not benefit. Each situation should be evaluated individually, ideally with the advice of a tax professional.
Q: Does the election affect liability protection?
A: No. The S-Corp election has no impact on the legal protections provided by the LLC structure. Members continue to enjoy limited liability protection for business debts and obligations, as long as corporate formalities are respected.
Q: What should business owners consider before making the election?
A: Before making the election, owners should consider factors such as expected net income, the owner’s role in the business, the ability to pay a reasonable salary, and the capacity to manage additional compliance obligations. They should also review their business’s long-term goals, funding plans, and operating structure.
Q: What’s the bottom line?
A: Electing to have your LLC taxed as an S-Corporation can be a strategic move to reduce self-employment taxes and retain more earnings. However, it comes with greater administrative responsibilities and stricter IRS rules. It’s not a one-size-fits-all solution and should be approached with careful planning and professional guidance
Need help deciding whether S-Corp taxation is right for your LLC?
The business attorneys at Moore Law are here to guide you through the process and ensure your structure supports your goals. Call us at (615) 747-7467, or use the chat option on our website to get started.
