LLC Taxed as an S Corporation: Here's What You Need to Know

Are you an LLC owner thinking about electing to be taxed as an S Corp? If you're still not exactly sure what is S Corp v. C Corp or how an LLC can be taxed as an S Corp, read our comprehensive guide on those issues.

This guide assumes you're trying to decide whether to be taxed as an S Corporation or to keep the default tax status. We'll go over the benefits and drawbacks, and give you a really easy rule of thumb at the end to apply to your business.

What is S Corp status for an LLC?

An LLC by default (meaning -- if you don't do anything) is taxed as either a:

• Disregarded Entity if one owner (same tax status as a sole proprietorship); or
• Partnership if more than one owner.

But, LLC's have the ability to elect, with the IRS, to be taxed as either an S Corporation or C Corporation, or to remain taxed as the default.

Benefits of LLC Electing S Corp Status

There are several benefits to electing S Corp status for your LLC, including:

1. Lower self-employment taxes: When an LLC is taxed as a pass-through entity, the members are subject to self-employment taxes on their share of the business profits. By electing S Corp status, the members can pay themselves a salary and only pay self-employment taxes on that salary, potentially saving money on taxes.

2. Tax savings on profits: With S Corp status, the business itself pays taxes on its profits at the corporate tax rate, which can be lower than individual tax rates. This can result in tax savings for the business and its members.

3. Limited liability protection: As an LLC, your personal assets are already protected from business liabilities. Electing S Corp status does not change this protection.

Drawbacks of LLC Electing S Corp Status

Here are some of the drawbacks to consider, including:

1. Additional paperwork and expenses: Electing S Corp status requires filing additional paperwork with the IRS and may require the help of a tax professional. There may also be additional expenses associated with maintaining S Corp status.

2. Restrictions on ownership and distribution: S Corps have restrictions on ownership and distribution of profits, which may not be ideal for all businesses.

3. Possible double taxation: If the S Corp distributes profits as dividends, the members may be subject to double taxation, meaning they pay taxes on the profits at both the corporate and individual levels.

When Does the S Corp Election Make the Most Sense?

For most new LLCs, it makes more sense to keep the default tax status initially. It's a bit simpler, and odds are you won't get the tax benefits of S Corp Status. However, if you know you're going to make $100,000 or more the first year and you're the only owner and have no employees, then an S Corp Election probably makes a lot of sense.

First some background. When you make the S Corp election, you'll need to pay yourself a salary that is taxed with self-employment taxes. The salary has to be at "market value." 

So, if you would make $60,000 with your job in the "real world," and you have expenses of another $20,000, then you'd have $20,000 in profit. On those $20 in profit, you can avoid the self-employment taxes (15-20% of the profit). This means that you'd save $3,000 to $4,000 a year in taxes. 

Most people initially don't have a profit though, in which case the S Corp election is just more paperwork. 

Also, you can always elect S Corp election in your second year, third year, etc. once you start to become profitable. 

Do you Qualify as an S Corporation?

To be an S Corporation, you need to:

• Be a domestic company;
• Have only permitted owners (Allowed: individuals, certain trusts, and estates. Not Allowed: partnerships or non-resident alien shareholders);
• Have no more than 100 shareholders/members; and
• Have only one class of stock.

How to Make the Election

To become an S corporation, the LLC must submit Form 2553 Election by a small business corporation signed by all the members. See the Instructions for Form 2553 for all required information and to determine where to file the form.

Do you need a lawyer for this?

The biggest question now is, "Do you need to hire a lawyer for help?" Sometimes, yes (especially if you have multiple owners). But often for single-owner businesses, you don't need a lawyer to start your business.

Many business owners instead use tools like Legal GPS for Business, which includes a step-by-step, interactive platform and 100+ contract templates to help you start and grow your company.