Key Takeaways

  • An LLC can elect to be taxed as an S corporation to reduce self-employment taxes and access tax planning strategies.
  • Filing Form 2553 with the IRS is necessary to elect S corp status after first filing Form 8832 if required.
  • S corp election benefits active businesses with stable profits and the ability to pay a reasonable salary.
  • S corp status comes with compliance obligations like shareholder limits, officer compensation, and strict filing deadlines.
  • The LLC's legal status remains the same—only its federal tax treatment changes.
  • There are potential drawbacks to consider, such as loss of flexibility and increased IRS scrutiny.

An LLC filing as an S-corp will be taxed differently than other LLCs. By default, single-member LLCs are taxed as sole proprietorships, and multi-member LLCs are taxed as partnerships. However, an LLC can elect to be taxed as an S-corporation instead by filing Form 8832 with the IRS.

About LLCs

An LLC, or limited liability company, is formed legally under state law in order for a business to operate. It's easy to form and run an LLC, and there are several advantages of a corporation that businesses can enjoy, such as having limited liability. An LLC is set up to give a corporation limited liability features, such as being flexible in how it operates and having tax efficiencies. 

Any losses or profits of the LLC go through the LLC to its owners, who are also known as members. Every member will report their profits and losses on their federal tax return. The same goes for a partnership or proprietorship. This setup helps business owners avoid getting taxed twice.

If an LLC is formed by a single member, it will be a disregarded entity. This means the individual will pay income tax as the sole proprietor on their personal tax return. A multiple-member LLC will pay income taxes in the form of a partnership. A member's personal liability will be limited to his or her investment in the limited liability company. This is different from the LLC as a general partnership or sole proprietorship, where every owner will be subject to liability for the business' debts.

The most important features of an LLC include the following:

  • Income passes through to owners, which prevents double taxation (unless corporate treatment is chosen).
  • There will be fewer meetings that are formal, fewer costs to start the company, fewer forms and filings, and fewer record-keeping requirements.
  • Owners have limited liability.
  • All net earnings of the LLC go to owners through self-employment income..

LLCs are not identified by the IRS as a taxpayer classification when it comes to federal tax purposes. Federal tax treatment is distinct from the limited liability, so members will be protected from liability whether they're a corporation, partnership, or sole proprietorship. LLCs that have one owner will be taxed as sole proprietorships. By default, LLCs with multiple owners will be taxed as partnerships. An LLC can decide to be taxed as an S-corporation or a C-corporation by filing an election with the IRS.

When the filing is complete, the LLC will be considered the same as a corporation according to the IRS. It will file the appropriate tax forms for that kind of entity. Many LLCs will decide to keep their default form of taxation. However, there are tax advantages for being taxed as an S-corporation. The tax advantage is due to the recently created pass-through tax deduction which was established by Tax Cuts and Jobs Act.

The LLC can choose to be treated as a company that's taxable as a corporation if they file Form 8832 (Entity Classification Election). After this is complete, Form 2553 (Election by a Small Business Corporation) needs to be filled out to choose to be taxed as an S-corporation. The LLC's legal status will stay the same even if the tax status is changed to an S-corporation or a corporation. This means the business can function as a normal LLC, but its taxes will be different.

LLCs vs S-Corporations

Business owners can benefit by forming an LLC and then choosing to be an S-corporation when it comes to tax purposes. An S-corporation election is a good choice for business owners if the LLC operates an active business or trade. This is also a good option if payroll taxes on the owners are particularly high. Both organizations will have their income passed through to the owners and give them limited liability protection.

An LLC has advantages over an S-corporation due to the ease of administration and operation. There's also flexibility when it comes to deciding what percentage of profits and losses each owner will receive. However, an S-corporation has an advantage over a regular LLC in that there is more flexibility when it comes to allocating the company's earnings to the owners through the form of either distributions or wages and salaries.

S Corp Election Considerations and Pitfalls

While there are tax advantages to filing as an S corp, there are also potential risks and administrative hurdles:

  • Misclassification Risks: If the IRS deems the salary paid to members as unreasonably low, it may reclassify distributions and assess back taxes and penalties.
  • Loss of Flexibility: LLCs normally offer flexibility in profit distribution. S corps must distribute profits in proportion to ownership, reducing this flexibility.
  • Stricter Compliance: S corps must follow stricter record-keeping, filing, and payroll procedures, which could increase accounting and legal costs.
  • Conversion Challenges: Converting back from an S corp tax election to default LLC taxation may not be straightforward and could have tax consequences​.

Filing Requirements for LLC S Corp Election

To elect S corp taxation, an LLC must file:

  1. Form 8832 (if the LLC is currently taxed as a partnership or sole proprietorship and needs to elect corporate treatment first)
  2. Form 2553 to elect S corporation status with the IRS

Timing is important. To be effective for the current tax year, Form 2553 must be filed:

  • No more than 2 months and 15 days after the beginning of the tax year the election is to take effect, or
  • At any time during the tax year before the one it will take effect​

In addition, the LLC must meet the following criteria:

  • No more than 100 shareholders (members)
  • All members must be U.S. citizens or residents
  • The LLC may issue only one class of stock (ownership interest)

When Should an LLC Elect S Corp Status?

Electing S corporation status is most beneficial for LLCs that:

  • Generate consistent profits beyond what would be paid as a reasonable salary
  • Are actively involved in operations (not passive investment entities)
  • Want to save on self-employment taxes
  • Can handle the additional administrative and compliance requirements of an S corporation​

If the LLC's earnings are modest or owners are not working actively in the business, the benefits of an S corp election may not outweigh the costs and complexity.

How LLC S Corp Election Impacts Taxes

When an LLC elects S corporation tax treatment, it alters how federal income taxes and employment taxes are calculated. While default LLC taxation results in all profits being subject to self-employment tax, an S corp structure allows owners to split earnings between salary and distributions. Only the salary portion is subject to employment taxes, potentially reducing the overall tax burden​.

However, the IRS requires that the salary paid to members actively working in the business be "reasonable" based on their roles and industry standards. Failure to comply with this requirement can result in penalties and reclassification of distributions as wages.

Frequently Asked Questions

  1. Can any LLC elect to be taxed as an S corporation?
    No. The LLC must meet IRS S corp eligibility requirements, including a limit of 100 shareholders and U.S. residency for all members.
  2. How do I file for S corp status as an LLC?
    You need to file IRS Form 2553 and possibly Form 8832, depending on your current classification. Make sure to file within IRS deadlines to avoid delays.
  3. Is there a deadline for making the S corp election?
    Yes, Form 2553 must be filed no more than 2 months and 15 days after the start of the tax year you want the election to apply.
  4. What are the main tax benefits of an LLC electing S corp status?
    The key benefit is saving on self-employment taxes by dividing income between salary (subject to employment taxes) and distributions (which are not).
  5. Does S corp election change my LLC’s legal structure?
    No. The LLC remains an LLC under state law. The S corp election only affects how the IRS taxes the business.

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