Key Takeaways

  • LLCs and S Corps both generally avoid double taxation through pass-through taxation.
  • LLCs can choose how they are taxed—by default as sole proprietorships or partnerships, or optionally as S Corps or C Corps.
  • Electing S Corp taxation may allow LLC owners to save on self-employment taxes.
  • C Corps are subject to double taxation: once at the corporate level and again on shareholder dividends.
  • LLC members must carefully track income classifications to ensure tax efficiency.
  • An S Corp must meet IRS eligibility requirements to retain its pass-through tax treatment.
  • Whether “are LLC double taxed” depends on tax election; by default, they are not.

S Corp double taxation is something that doesn’t occur, as only a C Corp is subject to the double tax implication. This means that C Corps must pay corporate income tax on all profits. The profits are then taxed again at the personal level if distributions are made to the C Corp shareholders. However, while C Corporations generally operate as separate and distinct entities from its owners, S Corps do not, as they are a sub-set of corporations. As such, they are not subject to double taxation.

S Corp: An Overview

Created in 1958, S Corps, also referred to as Sub-S Corporations, operate under Subchapter S of Title 1 of the Internal Revenue Code.

S Corps operate as pass-through tax entities, which means that the profits and losses of the business pass through to the owners who report it on their personal tax returns. Therefore, the S Corp shareholder must report a percentage of the profits and losses on their personal income tax returns even if they don’t receive that money in the form of a distribution.

However, if a shareholder does in fact receive a distribution, i.e. dividend, the money isn’t subject to self-employment tax. If the money is paid to a shareholder in the form of wages, then that money is taxable. This is one of the ways in which S Corp shareholders try to minimize their taxes.

Keep in mind that a Limited Liability Company (LLC) can also elect to be taxed as an S Corp. Since an LLC isn’t recognized as a legal entity in most states, it must elect to be taxed as either a partnership, C Corp, or S Corp. While an LLC already operates as a pass-through tax entity, the reason why an LLC would elect to be treated as an S Corp is due to the ability for the LLC members to divide the business earnings into salary and distributions. That way, the LLC member can receive a reasonable compensation while also earning dividends and not being subject to self-employment taxes through those dividend payments.

Avoiding Double Taxation

The S Corp and LLC are two of the most common and favorable business structures for small businesses, since both avoid double taxation. LLCs and S Corps are taxed more like a sole proprietorship or partnership as opposed to a C Corp, which is taxed as a separate entity from its owners. This means that the S Corp doesn’t pay taxes at the corporate level. As previously noted, all profits and losses are paid by the owners on their personal income tax returns.

Personal tax rates are generally lower than corporate rates, which means that S Corps usually pay less taxes than C Corps. The difference between S and C Corp taxation isn’t the percentage of income that is taxed, but instead where it is taxed, i.e. wages or distributions.

If you own 50 percent of an S Corp, then you’ll have to report 50 percent of the company’s profits on your personal tax return. However, if you own 50 percent of a C Corp, your taxes might differ greatly depending on how much compensation and dividends you were paid. C Corp dividends are taxed along with wages paid to the C Corp shareholder.

When an LLC Might Be Double Taxed

Although LLCs are generally not double taxed, there are certain scenarios where double taxation can occur:

  • C Corporation Election: If an LLC elects to be taxed as a C Corp, it will face double taxation. The LLC pays corporate income tax, and then members pay tax on dividends received.
  • Improper Classification of Payments: If the IRS reclassifies member distributions as wages due to unreasonable salary reporting, those amounts may be subject to both income and employment taxes.
  • State-Level Taxes: Some states impose entity-level taxes on LLCs regardless of their federal tax treatment, which could resemble double taxation in practice.

Understanding these nuances can help LLC owners structure their businesses to avoid unintended tax consequences.

LLC Tax Classification Options

One of the defining characteristics of an LLC is its flexibility in choosing how it is taxed. By default:

  • A single-member LLC is treated as a disregarded entity, taxed like a sole proprietorship.
  • A multi-member LLC is treated as a partnership for federal tax purposes.

However, LLCs also have the option to elect taxation as either an S Corporation or a C Corporation by filing IRS Form 2553 or Form 8832, respectively. This flexibility allows business owners to strategically manage their tax liabilities based on how they want profits and losses to be distributed and taxed.

This classification flexibility is one reason why, when asking "are LLC double taxed?" the answer is usually no—unless the LLC chooses C Corp taxation.

Simplified Tax Filing

One of the key benefits of the S Corp is the simplified process for tax filing. Again, since the S Corp doesn’t have to file federal taxes, a separate corporate tax return isn’t necessary. However, if you are an owner in an S Corp, you might have to file several forms along with your personal return (Form 1040). This could include separate forms if you receive both S Corp proceeds as well as C Corp dividends. You might also need to pay quarterly taxes on your personal tax return, particularly if you don’t have enough funds being taken out of your paycheck.

Self-Employment Tax Considerations for LLCs

For LLCs taxed as sole proprietorships or partnerships, members typically must pay self-employment tax on their share of the business’s earnings. This includes both the employer and employee portions of Social Security and Medicare taxes, which amount to 15.3% of income.

However, if an LLC elects to be taxed as an S Corporation, members can pay themselves a reasonable salary (subject to employment taxes) and take additional profits as distributions, which are not subject to self-employment tax. This is one of the most compelling reasons why LLCs may choose to be taxed as S Corps.

S Corp Qualification Status

Not all businesses qualify for S Corp status, as the IRS has the following requirements:

  • The business must operate as a domestic corporation.
  • The shareholders can’t be partnerships, corporations, or non-resident aliens.
  • There can’t be more than 100 shareholders.
  • Only one class of stock is allowed.
  • The business has to be eligible, i.e. some banks and insurance companies aren’t eligible.

Pros and Cons of LLC vs. S Corp Taxation

Advantages of S Corp Taxation for LLCs:

  • Self-employment tax savings through salary/distribution income split.
  • Pass-through taxation avoids corporate income tax.
  • Greater credibility with potential investors or partners.

Potential Drawbacks:

  • More administrative work, including payroll and tax filings like Form 1120-S.
  • Stricter IRS rules regarding compensation and distributions.
  • Eligibility limitations, such as number and type of owners.

Careful evaluation with a tax professional can help determine whether the S Corp election makes sense for a specific LLC’s goals.

How LLCs Can Elect S Corp Taxation

To elect S Corporation tax status, an LLC must:

  1. Be a domestic entity.
  2. Have only allowable shareholders (individuals, certain trusts, and estates).
  3. Not have more than 100 shareholders.
  4. Have only one class of stock.
  5. File Form 2553 with the IRS within the required timeframe—generally within 75 days of formation or the start of the desired tax year.

Once approved, the LLC retains its legal structure but is taxed as an S Corp, which can offer strategic advantages, particularly related to self-employment tax.

Frequently Asked Questions

  1. Are LLCs subject to double taxation?
    Generally, no. LLCs benefit from pass-through taxation unless they elect to be taxed as a C Corporation.
  2. When would an LLC experience double taxation?
    Double taxation can occur if an LLC elects C Corp tax treatment or faces certain state-level entity taxes.
  3. Why might an LLC elect S Corp taxation?
    To reduce self-employment taxes and maintain pass-through taxation while gaining potential tax savings on distributions.
  4. What is the difference between an LLC and an S Corp?
    An LLC is a legal structure, while S Corp refers to a tax classification. An LLC can choose to be taxed as an S Corp.
  5. Do all LLCs need to file Form 2553 to avoid double taxation?
    No, only LLCs electing S Corp status file Form 2553. Default treatment as a sole proprietorship or partnership avoids double taxation as well.

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