LLC Electing S Corp Status: Everything You Need to Know
LLC electing S corp status occurs when a LLC opts to be treated as an S corporation by the IRS to take advantage of beneficial tax treatment.5 min read updated on January 01, 2024
An LLC electing S corp status occurs when a limited liability company opts to be treated as an S corporation by the IRS to take advantage of beneficial tax treatment. In many cases, S corporation status is desirable because, in an LLC, a partner must pay a substantial self-employment tax on his or her share of the company's income. S corporation owners do not have to pay this tax.
S corporations and LLCs are two of the most popular legal structures for small businesses, so many businesses face a challenge when it comes to choosing between the two entities. In some cases, LLC status is advantageous at the state level but not for tax purposes. Being able to form an LLC and then electing S Corp status is thereby beneficial to individuals in such situations.
Differences Between LLCs and S Corporations
Both LLCs and S corporations have the following characteristics.
- They operate under a “pass-through” tax treatment.
- They don't pay taxes based on the business' profits but rather are passed along to the owners and reported individually.
- They help keep the owners and the businesses separate and provide liability protection.
Differences include the following:
- An LLC is typically easier to run in terms of administrative work because of fewer state filings and forms, lower start-up costs, and fewer formal meetings and less documentation.
- An LLC is more flexible in how owners divide profits and losses among owners.
- When an LLC has more than one owner, it is treated as a partnership by the IRS by default. Single-owner LLCs default to sole proprietorships for tax purposes.
- The S corporation is more flexible in how profits are divided and paid to the owners.
To combine your LLC with an S corporation, you have to first formalize your business as an LLC, and then elect to have it treated as an S corporation by the Internal Revenue Services (IRS).
Legally, your company will be an LLC, which means that you will receive the advantages of an LLC. This includes fewer filings with the state, less paperwork, and generally lower costs.
From the perspective of the IRS, your business will be an S corporation. You will get the pass-through income of a sole proprietorship or partnership, but with the added flexibility of dividing some of the company's income.
S Corp Election
When an LLC elects S corp status, all of its liabilities and assets are exchanged for stock in the new corporation, which is then liquidated and distributed to its owners. This transfer is not taxable as long as the LLC's debts do not exceed its assets. S corp status can then be elected if all members qualify to do so.
This election requires the completion of IRS Form 8832. The effective date for the election can be within 75 days of the filing date. A new LLC must file this election by the middle of the third month after the entity is created. This requires IRS Form 2553. This form also allows you to choose between a calendar tax year or an alternate fiscal year.
You can also elect S corp treatment when you file your business tax return by including both Form 2533 and Form 1120S along with an indication of the consent of all LLC members for this election.
S Corp Status Considerations for Partnerships
If a partnership decides to elect S corp status, the process is the same as an LLC as far as exchanging assets and liabilities for stock in the new corporation. This conversation can take place at the beginning of the year if you want the transaction to be treated as if it occurred just before the close of the previous tax year. If done correctly, S corporation status will be granted right away, and you won't be taxed as a C corporation for part of the year. This also preserves your owners' limited liability and retains the convenience of pass-through taxation.
Taxation of S Corporations
The following are guidelines about the taxation of S corporations:
- An S corporation is subject to pass-through tax status. This means that owners report the business's income and losses on their individual tax returns, thus avoiding double corporate taxation.
- S corporations report their income and deductions.
- S corporations file information return forms reporting the corporations' tax credits, profits, losses, income, and deductions for the tax year in question.
- Shareholders are given a Schedule K-1 that indicates the share of the above items that must be reported on individual tax returns. Each shareholder also pays a percentage of employee Medicare and Social Security tax.
- Being categorized as an S corporation worker also has one big benefit: S corporation tax treatment can offer a technique to get some cash out of your corporation. This happens without expending service taxes since you do not have to recompense service tax on deliveries (bonuses) from your S corporation—that is to say, on salaries and incomes that pass through the formation to you as a possessor, not as a worker in reward for your services.
The bigger your circulation, the less employment tax you will need to pay. The S corporation is merely the commercial form that makes it likely for its proprietors to save on Medicare taxes and Social Security which is the main reason it has been and continues to be popular with specialists. S corporation position is permitted only if:
- The stock has simply 100 stockholders.
- None of the entity's nonresident aliens are stockholders —that is to say, nonresidents who are not living in the United States.
- The entity has just one category of stock—for instance, there can't be ideal stock providing some stockholders special privileges.
- None of the entity's stockholders are other partnerships or corporations.
Owners who work in the business are treated as employees rather than business owners as with an LLC. This allows the individuals to avoid hefty self-employment tax. Each owner thus receives a reasonable salary for his or her services.
Corporations that have employees must withhold Social Security and Medicare (FICA) taxes and remit them to the IRS on the workers' behalf.
Issues Associated with a Single Stock Class
When an LLC elects S status, it is essential that its operating arrangement and other documents adapt to the S corporation suitability prerequisites. Any previous documents founded on the LLC's treatment as a partnership will need to be revised or exchanged.
Allocations founded on anything beyond the percentage of tenure breach and the single stock class rule are not acceptable in an S corporation. All shareholders must be in the same stock class. However, both voting and non-voting shares of company stock can be issued if you plan to designate voting rights.
The working contract of a limited liability company (LLC) functioning as a partnership may stipulate that some members are general partners and that others are considered limited partners. Also, the Internal Revenue Service (IRS) has decided that the limited and general partnership welfares that discuss identical privileges to liquidation and distribution proceeds meet the one-class-of-stock condition.
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