LLC S Corp Tax Structure: Everything You Need to Know
LLC S corp tax structures are different from other types of business tax structures. Since Delaware set the framework for LLCs, in 1991, the IRS has changed their take on tax status of LLCs several times.4 min read
LLC S corp tax structures are different from other types of business tax structures. Since Delaware set the framework for LLCs, in 1991, the IRS has changed their take on tax status of LLCs several times. Currently, you are able to choose how your business entity is taxed. The options are sole proprietorship, general partnership, S corporation, and C Corporation. Many people choose a partnership or sole-proprietorship. However, there are great benefits to choosing the S corp election.
Even a room full of esteemed lawyers can debate which is better S corporation or LLC. You do not have to choose which you want to form though. You can file an LLC and elect to be taxed as an S corp. An S corporation might be the correct choice if your LLC is an active trade company and the owners are paying high SECA taxes.
By default, each entity is issued a specific taxation. For example, a multi-member LLC is taxed as a partnership, unless otherwise elected. LLCs do retain the right to taxation as a C corp or S corp. All you have to do is file the election form, IRS Form 8832, with the Internal Revenue Service. As far as the IRS, when this is done, the LLC becomes a corporation.
Everything LLCs and S Corporations Have in Common
However, the LLC can alternately choose S corporation taxation to take advantage of some benefits. The pass-through tax deduction created by the Tax Cuts and Jobs Act makes this especially true. With both, the owners are not responsible for the debts and liabilities of the business entity.
Both the S corporation and the LLC are formed by filing with your state. LLCs only have to file business tax returns if the LLC has more than one owner. However, both share the "pass-through" tax benefits. All necessary funds, including profits and losses, are reported on the personal tax level on the individual's tax return. There are state-mandated formalities for both, such as annual report filing and arranging to pay all necessary fees.
Differences Between S Corps and LLCs
When it comes to ownership, the IRS governs S corporation status but does not regulate LLCs. There can be an unlimited number of members in an LLC; S corporations are restricted to 100 owners or shareholders. Non-United States citizens are allowed to form LLCs but not S corps. S corporations are not owned by other S corporations, partnerships, LLCs, and most trusts. There are no restrictions on LLC subsidiaries.
There are more internal formalities for S corps, while LLCs do not have to adhere to internal formalities.
Recommended LLC Formalities:
- Adopt an operating agreement;
- Issue member shares;
- Hold and document member meetings annually;
- Document all major decisions.
Required S Corporation Formalities:
- Adopt bylaws; issue stocks;
- Hold annual and initial shareholder meetings;
- Keep careful meeting minutes in the company's corporate records.
Why Choose an S Corporation
When you decide to form an S corporation, you are legally an LLC, so you have fewer requirements, the Franchise Tax is fixed, and there is more flexibility in the structure of your company's management. So, in terms of tax, your business is an S corp, which means you receive corporate tax breaks, pass-through tax benefits, and there is no double taxation.
Furthermore, the members will claim profits and losses on their income tax return personally, which is like a partnership. The most popular reasons to form an S corporation are to maintain your company's profits and remove the requirement to pay self-employment taxes.
How S Corporations Are Taxed
Companies are taxed on net losses and profits, which is computed by subtracting allowable deduction expenses from total sales. The entity's tax is paid when the owners file their individual tax returns and is based on each owners percentage of ownership in the company.
When you own an S corporation, you are paid a salary as a working owner. An S corporation is like a partnership in terms of pass-through taxation. S corps report income and deductions by filing an IRS Form 11205 information return which includes the following:
- Tax Credits
All shareholders receive a Schedule-K, which lists the number of shares they own of the items on the company's Form 1120S. The owners then file Schedule E with their Form 1040 or personal tax returns showing how much of the company's profits and losses they own. The employment status of the owners is what is different between an S corp and an LLC.
All of this can be pretty confusing. So it is a good idea to check with a professional CPA or a tax attorney. If you need help with LLC and S corporation tax structures, you can post your legal need on UpCounsel's marketplace. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience and work with companies like Google, Menlo Ventures, and Airbnb.