LLC S Corp Election Form: Everything You Need to Know
The LLC S Corp Election Form is used when an LLC wishes to be considered an S corporation for the purposes of paying taxes. 4 min read
2. What's the Difference Between an S-Corp and an LLC?
3. How is an LLC Taxed?
4. Why use an S Corporation for Tax Purposes?
5. Are There Disadvantages?
The LLC S Corp Election Form is used when an LLC wishes to be considered an S corporation for the purposes of paying taxes. This saves the owner of an LLC from having to pay self-employment tax on his share of the business because an S corporation owner does not pay this tax on his pass-through income or other distributions.
The process of converting your LLC to an S-corp for this purpose may be complicated but may be worth the effort. It can be done at the same time you file your tax return by filing the necessary documentation at that time. However, your election may not be in effect until the following year, so the current year's tax return should be done as usual. It also does not change the fact that your LLC is still, for all other purposes, an LLC.
What's the Difference Between an S-Corp and an LLC?
S-corp, or S-corporation, is a short form of “Subchapter S Corporation.” It is a tax entity of its own, not just a legal entity designated by the state. Its classification is done with the IRS instead. In the case of using the designation of S-corp for tax purposes, it is used in addition to your LLC. LLCs and S-corporations are “pass-through” entities and do not have their profits subject to double taxation as a C-corporation would. All profits and losses are passed through to the owners, who report them on their own personal tax returns.
How is an LLC Taxed?
- The income taxes paid by an LLC are based upon the company's members or owners.
- Single-member LLCs are considered “disregarded entities” and are treated like a sole proprietorship, with all profits and losses reported by the single owner's tax return.
- Multiple-member LLCs pay income taxes the same way as a partnership would pay, by dividing profits and losses by each member's share of ownership.
Why use an S Corporation for Tax Purposes?
If your LLC is eligible for S corporation status, it can save you money on self-employment taxes. This covers social security and Medicare taxes, and it is reported on your personal tax return. This is possible because an S corporation divides your income into salary and distribution, or dividends. You effectively become an employee of the S corporation as well as the owner, and self-employment tax is only applied to the salary portion of your income. The only restriction to doing this is that you need to take a “reasonable” salary, or the IRS will see that you are trying to circumvent paying your fair share of taxes.
To take advantage of these tax savings, there are administrative tasks you must attend to:
- You must have a payroll system, even if you are the only owner because you must pay yourself a salary.
- You must file payroll returns, both federal and state, on a quarterly basis.
- You need to do bookkeeping to maintain accurate records.
- You need to file corporate tax returns; usually, this is done by a professional accountant.
- If you have employees, you may need to pay for unemployment insurance on both state and federal levels, worker's compensation insurance, and unemployment insurance.
Are There Disadvantages?
The costs of these items may offset any tax savings you may receive as a result of electing an S-corp status, so you need to run the calculations before making the choice. There are other disadvantages to choosing S-corp status as well:
- S corporations have a higher risk of audit by the IRS, so you'll need to keep accurate records and make sure your salary is honestly a reasonable amount.
- Your social security benefits are based on your salary, so if you pay yourself less, over time the amount of social security you ultimately receive upon retirement will be lower as well.
- You may have a tougher time being approved for a mortgage if your salary is reduced to avoid paying self-employment taxes.
- Your maximum contributions to a personal retirement account are based upon the salary you receive, so paying yourself less means less money in your retirement nest egg.
Be sure to consider all aspects of your business including long-term goals, as well as your personal goals when choosing an entity for your business. An attorney who is familiar with all forms of tax entity, as well as a professional CPA, can assist in your decision.
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