LLC S Corp Election: Everything You Need to Know
LLC S Corp election allows limited liability companies to seek a new status for tax purposes. 3 min read
2. LLC and S Corporations: Key Differences
3. Electing S Status for a Corporate Entity Under the Check-the-Box Rules
4. Potential One-Class-of-Stock Issues
LLC S Corp election allows limited liability companies to seek a new status for tax purposes. By electing S corp status, your LLC can benefit in a number of ways. This means that you can structure your company as an LLC but pay taxes as an S corporation. By taking this step, you will be able to enjoy the operational flexibility of an LLC, combined with the tax perks of an S corporation.
What is an LLC?
An LLC or "limited liability company" is a type of legal entity that is used to run a business. This structure is designed to offer the owner(s) limited liability protection — just like a corporation. Being a hybrid entity, LLCs also have characteristics of a general partnership or sole proprietorship.
Offering many of the advantages associated with a corporation, LLCs are easier to form and are more flexible. However, the IRS does not recognize LLCs, which is why the company must file as either a sole proprietorship, partnership, or a corporation.
In terms of the owners of an LLC, they are referred to as members. Unlike a corporation, there is no limit to the number of members involved. However, these members enjoy personal liability similar to those who own a corporation.
When preparing for your taxes, if you are a single-member LLC, you will be considered a disregarded entity. You will pay taxes as a sole proprietorship, claiming all of the LLC's income and losses on your personal tax return. If there are multiple members involved, you will be taxed as a partnership.
Although the majority of LLCs continue to operate under their default tax classification, some choose to be elected as an S corporation. This offers a number of tax benefits.
LLC and S Corporations: Key Differences
S corporations and LLCs are desirable among small business owners due to "pass-through" tax treatment. In comparison to a C corporation, neither an S corp or an LLC pay taxes on the business itself. Instead, all of the company's profits are passed onto the owners.
Although similar, there are some key differences, including:
- From an administrative point-of-view, an LLC is easier to run.
- LLCs require fewer forms and filings, resulting in lower start-up costs.
- An LLC also benefits from greater flexibility in regards to ownership percentages.
- An S corporation, however, provides greater flexibility in how owners are paid.
- S corporations also offer greater benefits in terms of taxation.
Electing S Status for a Corporate Entity Under the Check-the-Box Rules
As discussed, you can seek S corporation election for your LLC. If you do make this election, you will:
1. Need to transfer all of your company's assets and liabilities to the corporation.
2. Distribute stocks to your owners.
This is a tax-free transfer, as long as you meet certain requirements. For example, your liabilities cannot exceed your assets. To complete this process, you will typically need to file Form 8832.
Potential One-Class-of-Stock Issues
If you do elect S status, you will need to ensure that all of your paperwork conforms to the requirements of an S corporation. This is particularly true in relation to your operating agreement. For example, if your current LLC operating agreement allows for special treatment of certain members, this would mean that you have more than one stock. In this case, you would not be eligible for S corporation status.
Please note that an S corporation's shareholders must all be of the same class. This means that you cannot distribute special rights among different shareholders. This is where your operating agreement may differ if you were previously operating as a partnership. If you are unfamiliar, it is recommended that you thoroughly understand the" one class of stock requirement" as stated by the IRS.
Overall, being classified as an S corporation offers some clear advantages in how you distribute your money and in turn, pay taxes. There are some restrictions, however, S corporation requirements do not often cause issues for small businesses. For example, you cannot have more than 100 shareholders. If you are unsure whether your LLC would benefit from S corp election, it is best to seek professional advice.
If you need help understanding LLC S corp election, you can post your legal 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.