LLC S Corp Taxes: Everything You Need to Know
Comparing LLC and S corp. taxes is the first thing business owners do while setting up a new business or changing a business structure.3 min read
2. How Are LLCs and S Corporations Taxed?
3. Benefits of Electing an LLC as an S Corporation
4. LLC and S Corp. Similarities and Differences
Electing an LLC as an S Corp
Setting up an LLC or an S corporation has its own share of advantages and disadvantages. You can elect the S corp. status after setting up an LLC. If the members of your LLC are paying high self-employment taxes, you may want to consider converting to an S corp.
Your business cannot start out as an S corporation. You can elect the S corp. status only after you have a business structure in place. An LLC can fill out Form 8832 to apply to convert to a corporation for tax purposes. It can then file Form 2553 to re-structure as an S corporation.
When you set up an LLC first and subsequently elect the S corp. status, you stand to get the best of both: an LLC's ease of administration and an S corporation's tax benefits.
In order to be eligible for S corporation status:
- Your company must not have more than 100 shareholders
- No shareholder should be a nonresident alien
- Your company should not issue more than one class of stock
- A corporation or a partnership should not be a shareholder in your company
The S corp. status comes into effect from the date entered in line 8 of the election form. The S corp. election will not be effective earlier than 75 days or later than 12 months of filing the election.
Once the S corp. status goes into effect, owners must transfer business assets and liabilities to the corporation in exchange for shares. When an LLC chooses to be a corporation or an S corporation for the purpose of taxation, its legal status still remains as an LLC for all other purposes.
Since the IRS does not treat an LLC as a separate tax entity, the company pays income tax based on its membership structure. If the company is a single-member LLC, the owner pays income tax through his personal tax return, just like a sole proprietor. Similarly, owners of a multiple-member LLC will pay income tax like a partnership.
How Are LLCs and S Corporations Taxed?
An LLC's income is included in the owners' individual tax returns based upon their ownership percentage. An S corporation can deduct the salary paid to its owner-employees from its income. The remaining income after deduction of all allowable expenses is included in the individual tax returns of the owners. The owner-employees must also include the salary received from the S corp. in their personal tax return.
Benefits of Electing an LLC as an S Corporation
Despite electing S corporation status, legally, the company still remains an LLC for all purposes other than taxation. So you can continue to enjoy the flexibility that an LLC offers, like fewer filings and formalities, less stringent record keeping, and lower startup costs. You can also enjoy the taxation benefits associated with S corp. status, such as pass-through of business income to owners, saving yourself from double taxation.
You can pay salaries to employee-owners. The amount of salary so paid will be subject to FICA and SECA taxes. However, no such taxes would apply to the remaining income, which can be distributed among owners as passive dividends. S corp. status allows you to budget for your taxes better and minimize you and your business' tax liability.
You should choose the business structure that lowers your tax liability. Personal tax rates for higher income brackets are usually higher than corporate tax rates. If including the LLC income puts you in the highest income bracket and increases your personal tax liability, you may want to remove the LLC income from your personal tax filing by converting your LLC into a corporation.
LLC and S Corp. Similarities and Differences
- Both of these business entities pass through their business income to their owners.
- Both of them offer limited liability to their owners.
- An LLC is easier to operate than an S corporation.
- Sharing business profits among owners is relatively easier when operating an LLC.
- An S corporation offers more flexibility in paying salaries to employee-owners.
- An S corporation offers better scope for tax planning than an LLC.
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