Can a Single Member LLC Elect S Corp Status: Everything You Need to Know
The IRS does not consider an LLC a taxing entity. In an LLC, taxes are paid according to its membership structure. An LLC with only one owner, also known as member, is classified as a disregarded entity. 3 min read
“Can a single-member LLC elect S corp status?” is a consideration that an owner of a single-member limited liability company (LLC) may make in order to obtain the tax benefits of an S corporation. By changing its business structure to S corp, such an LLC can reduce its self-employment taxes. However, paying taxes as an S corporation requires more paperwork.
How an LLC Pays Taxes
The IRS does not consider an LLC a taxing entity. In an LLC, taxes are paid according to its membership structure. An LLC with only one owner, also known as member, is classified as a disregarded entity. As such, it reports and pays its taxes the same way a sole proprietor does: through the personal tax returns of its member.
As a disregarded entity, a single-member LLC protects you from personal liability the way an LLC does, while allowing you to be taxed as a sole proprietor, with your profits or losses flowing through to your personal tax returns. An LLC with multiple owners, on the other hand, is taxed as a partnership.
Benefits of Electing S Corp Status
An LLC has the option of electing S corp tax status, but it must meet certain eligibility requirements. Similar to a sole proprietorship and LLC, an S corporation has a pass-through tax structure, meaning that its income taxes will pass through to its owners to be reported and paid at the individual level. By doing so, it enables a business to escape the double-taxation problem that affects corporations.
In addition, an S corporation keeps its owners separate from the company, allowing them to be treated as employees and withholding payroll taxes from their incomes. It is beneficial for an LLC to elect S corp status if it is profitable and its owners are required to pay large amounts of self-employment taxes, such as Social Security and Medicare taxes.
As the owner of a single-member LLC with S corp status, you are not regarded as a self-employed person. Therefore, you do not have to pay federal self-employment tax. However, since you are regarded as an employee, you have to take some or all of your company's available profit as a salary. You can then take the remaining profit as a dividend to avoid employment-related taxes and double taxation.
If you are a single-member LLC with disregarded entity status, you are required to pay self-employment taxes. By electing S corp tax status, you will be able to avoid self-employment taxes on the money you receive as dividends.
Determining "Reasonable" Salary
You may be tempted to receive all your money from your company as a dividend so that you can avoid self-employment taxes altogether. Nonetheless, the IRS prohibits this approach by requiring you to pay at least “reasonable compensation” to yourself as salary. Knowing how much compensation is reasonable can be difficult. The IRS has listed ten factors for determining reasonable compensation. Some accountants use a 60/40 rule, which requires 60 percent of profits to be received as salary and the remainder as dividends.
How to Elect S Corp Status
Similar to how a corporation elects S corp status, a single-member LLC can become an S corporation by filing IRS Form 2553. The LLC must file the election no later than two months and 15 days from the start of the tax year in which the S corp status will be effective. There is a certain timeframe in which the S corp status can take effect. It is mandatory that the new status goes into effect within 75 days before or 12 months after the filing date.
Electing S corp status also means that you must submit additional tax documents every year. One of these documents is IRS Form 1120S, which is the income tax return for S corporations. Certain aspects of filing S corp status can be daunting, such as:
- determining a reasonable salary
- setting the right time for the S corp to go into effect
- extra administrative paperwork
To ensure smooth filing, it is recommended that you work with a certified public accountant or tax expert.
If you are electing S corp status just to avoid self-employment taxes, it can be a decision that you will later regret. The extra effort and cost incurred may make the endeavor not worthwhile for some single-member LLCs.
If you need help with electing S corp status, you can post your need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.