LLC S Corp taxation takes place when a limited liability company (LLC) elects to be treated as an S Corporation in the eyes of the Internal Revenue Service (IRS).

LLC Electing S Corp Status

LLCs and S Corps are the top two business structures used by business owners today. 

These are both pass-through entities when it comes to business profits, and they both protect their owners (members or shareholders) from liability. 

Here are a few comparisons to consider between the LLC and S Corp structure to keep in mind when deciding on the right organizational choice for your business:

  • LLCs are easier to form and maintain with the state (fewer filings and requirements than S Corps).
  • LLCs have more freedom than S Corps when it comes to deciding how company profits will be distributed.
  • S Corps can decide to pay profits to employees, owners, and/or shareholders with profit distributions or salaries and wages. 
  • S Corps are more appealing than LLCs when it comes to tax planning.

LLCs offer the liability protection of a corporation and the taxation benefits of partnerships and proprietorships. 

The income of an LLC passes-through to the members of the company unless the business has chosen corporation status for taxation. As the members absorb the income of the business, they are required to include it on their personal income tax returns. This avoids having the income of the business taxed twice like it is with a corporation. 

Members of LLCs are only held responsible for the amount of their capital investment in the business, so the LLC structure protects the personal assets of members in case the business faces legal trouble or unpaid debts. Owners of partnerships and sole proprietorships are held financially responsible for any debts if the business goes under. 

Many business owners find the structure of an LLC to be very appealing because it offers:

  • Liability protection
  • Income pass-through
  • Avoidance of double taxation
  • Fewer requirements with the state (filing, reporting, fees, etc.)
  • Freedom in profit distribution practices
  • Self-employment taxation on distributed profits

No matter how an LLC chooses to be taxed, the members of the company are still protected from liability. 

Combining the Benefits of the LLC and the S Corporation

Many business owners can benefit by choosing the LLC business structure and filling for S Corp taxation. This will combine the features of LLCs and S Corporations, offering the many benefits of both. LLC members will need to file Form 2553 with the IRS in order to elect S Corp status for their LLC. 

If you choose to elect S Corp status for an LLC rather than just starting a corporation, you will benefit from:

  • Easier administrative duties than a corporation
  • Pass-through taxation practices (no double taxation)
  • The business being viewed as completely separate from its owners in the eyes of the IRS
  • The ability to give wages and salaries to any owners and employees and even yourself
  • Dividend income avoiding self-employment taxes
  • Better opportunities for tax planning to limit liabilities and enjoy certain fringe benefits
  • Getting the best of both LLC perks and S Corp perks

How Are S Corporations Taxed?

S Corps file Form 1120S, which is an information return that includes the following information for the S Corp for the year:

  • Income
  • Profits
  • Losses
  • Deductions
  • Tax credits

All owners or shareholders in the S Corp will need a Schedule K-1 form provided by the company that lists their individual shares from the monies included on the corporation's information return. In addition to their personal tax return, shareholders will fill out a Schedule E that reports the amounts on their Schedule K-1 form. 

Owners of S Corps are treated as employees of the corporation, which is different from the owners of partnerships who are just treated as the business owners when it comes to taxes. 

S Corp owners might be active or inactive shareholders, but they will be treated as employees as well as shareholders when reporting taxes for the company. 

One of the requirements of an S Corp is that owners, who are also employees, of the corporation have to be paid a salary for their services to the company. These owners will pay personal income taxes on the shares they take from the business, and they'll pay taxes on their salaries. 

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