Key Takeaways:

  • LLC tax status determines how the IRS taxes the business and can be the default classification or elected by the owners.
  • Default tax treatment: single-member LLCs are taxed as sole proprietorships; multi-member LLCs are taxed as partnerships.
  • LLCs can elect to be taxed as a C corporation or S corporation for potential benefits such as reduced self-employment taxes, tax planning opportunities, or attracting investors.
  • C corporation status subjects profits to double taxation but may provide expanded deductions and fringe benefits.
  • S corporation status allows pass-through taxation while enabling owners to pay themselves a reasonable salary and potentially reduce self-employment taxes.
  • Certain elections require filing specific IRS forms (Form 8832 for C corp status, Form 2553 for S corp status) and meeting eligibility deadlines.
  • Choosing an LLC tax status should consider factors like profit levels, payroll costs, reinvestment plans, and long-term growth goals.

The LLC tax status your company has may be set by default or may be elected by you for tax purposes. In general, the IRS taxes single-member LLCs as sole proprietorships and multi-member LLCs as partnerships. You may choose to be taxed as a corporation if you find it more beneficial.

LLC Tax Options

By default, the IRS taxes new LLCs the same as sole proprietorships or partnerships, based on whether they have one owner — or member — or multiple members. The business doesn't pay taxes; instead, the members pay taxes on their share of the profits and file individual tax returns.

In a single-member LLC, the owner files his or her own return and includes Schedule C, which reports the LLC's profits and losses. The member is also responsible for self-employment taxes, which includes Medicare and Social Security.

Multi-member LLCs file an information return on Form 1065, which details the business's profits and losses. Each partner includes a Schedule K-1 on his or her personal tax return, detailing his or her share of the company's profits and losses.

Factors to Consider When Choosing an LLC Tax Status

Selecting the right LLC tax status depends on your company’s unique financial situation and long-term strategy. While the default sole proprietorship or partnership status offers simplicity, other structures may yield tax advantages. When evaluating your options, consider:

  • Profit Margins: Higher profits may make an S corp election appealing to reduce self-employment taxes.
  • Owner Compensation: If you plan to draw a regular salary, S corp or C corp treatment can provide structured payroll and potential tax planning opportunities.
  • Reinvestment Needs: C corporation taxation may be beneficial if profits will be retained in the business for growth.
  • Number and Type of Owners: S corps have restrictions on shareholder number and eligibility, while LLCs taxed as partnerships or C corps are more flexible.
  • Administrative Complexity: Corporate elections come with added compliance requirements, including payroll systems and separate tax filings.

Careful planning can help avoid paying more tax than necessary while aligning with your operational goals.

Changing Your Tax Status to a C Corporation or S Corporation

Some LLC members may find it beneficial to be taxed like a C corporation or an S corporation. If you decide to make the change, your LLC retains its legal status, so your business is treated like an LLC in all ways except for taxation.

Steps and Deadlines for Changing LLC Tax Status

Changing your LLC tax status requires timely filing with the IRS and compliance with specific deadlines:

  1. Determine Eligibility: Review IRS guidelines for your desired classification, including ownership, entity type, and operational requirements.
  2. File the Correct Form:
    • C Corporation: File IRS Form 8832 (Entity Classification Election).
    • S Corporation: File IRS Form 2553 (Election by a Small Business Corporation) within 75 days of formation or within 75 days of the start of the tax year.
  3. Get Member Consent: All LLC members must agree to the change in classification.
  4. Adjust Accounting Practices: Update payroll systems, accounting methods, and bookkeeping to meet your new tax obligations.
  5. State-Level Requirements: Some states require separate filings or fees when changing tax status.

Missing IRS deadlines can delay your election until the next tax year.

C Corp Status

You'll file form 8832 with the IRS to be taxed like a C corp. When you complete form 8832, you'll answer a series of questions and provide details related to the following:

  • In the first section, you'll determine your company's eligibility to make this change.
  • In the next section, you'll choose your current entity type and the type you wish to change to. The terms “domestic” and “foreign” don't apply to a country; they apply to the state where your business is located. Therefore, a domestic company is in the same state you originally registered and a foreign company is in another state you're registered to do business.
  • The final section contains a consent statement. You'll provide member signatures.

This is quite a complicated form, so it's recommended that you receive advice and assistance from an attorney when completing it.

Advantages and Disadvantages of C Corporation Taxation

Electing C corporation taxation can offer distinct advantages:

Advantages:

  • Expanded Deductions: Ability to deduct certain employee benefits like health insurance and retirement contributions.
  • Retained Earnings: Profits can be left in the company for reinvestment without passing through to members.
  • Unlimited Shareholders: Easier to attract investors and issue multiple classes of stock.

Disadvantages:

  • Double Taxation: Corporate profits are taxed at the entity level, and dividends are taxed again on shareholders’ personal returns.
  • Increased Formalities: Requires corporate recordkeeping, annual meetings, and separate tax filings.

C corp taxation often suits companies planning significant growth or those seeking outside investors.

S Corp Status

You might also elect to be taxed as an S corp. To elect S corp status, you'll file form 2553 with the IRS. You must make the election within 75 days of your LLC formation or within 75 days after the start of your tax year. Otherwise, the election will take effect the following year.

Following are the eligibility requirements for S corp status:

  • Your LLC must be a domestic company.
  • Your LLC can have no more than 100 shareholders.
  • Your shareholders must be individuals (U.S. citizens or resident aliens) and certain trusts or estates.
  • You must have an approved fiscal year end.

Both LLCs and S corps are pass-through entities, which means that business profits (and losses) pass through the company to the members. However, S corps can do some forms of tax planning that LLCs can't. 

Members may work as employees in the company and earn a salary. Other earnings that members receive are considered dividend income.

Two benefits that S corps provide include the following:

  1. They don't have the double taxation that C corps do.
  2. They create a legal separation between the business and the members. When members work as employees in the company, they're subject to payroll withholding. By not having to pay self-employment taxes all on their own, they may relieve some of their tax burden.

Even if you elect S corp status for tax purposes, your business is still legally an LLC. You have fewer complexities and formalities than a C corp. You also have more flexibility in your company's structure.

Many business owners who choose a different tax status than their default one often do so to gain certain benefits, such as tax savings or increased investment opportunities. You can always consult with tax and legal professionals to help you make the best decision for your company, now and in the future.

Tax Planning Benefits of S Corporation Status

S corporation taxation offers pass-through treatment while enabling members to be treated as employees:

  • Salary and Distributions: Owners can receive a reasonable salary subject to payroll taxes and take additional profits as distributions, which may not be subject to self-employment tax.
  • Reduced Self-Employment Tax: Only wages are subject to Social Security and Medicare taxes, potentially lowering the overall tax burden.
  • Pass-Through Losses: Business losses can offset owners’ other income, subject to IRS limits.

However, S corps must comply with:

  • Shareholder Restrictions: No more than 100 shareholders, all of whom must be U.S. citizens or resident aliens.
  • Equal Distributions: All shareholders must receive distributions proportionate to their ownership percentage.

For LLCs with steady profits and active owners, S corp status can yield significant tax savings.

Frequently Asked Questions

1. What is the default LLC tax status with the IRS? Single-member LLCs are taxed as sole proprietorships, and multi-member LLCs are taxed as partnerships by default.

2. Can I change my LLC tax status at any time? Yes, but you must meet IRS deadlines—typically within 75 days of formation or the start of the tax year for S corp elections.

3. Does changing my tax status affect my LLC’s legal protections? No. Your LLC remains legally an LLC; only the way it’s taxed changes.

4. Which is better for reducing self-employment taxes: S corp or C corp? S corp status often reduces self-employment taxes for actively involved owners, while C corp taxation generally does not.

5. Do states recognize the same LLC tax status as the IRS? Not always. Some states have different rules or additional filings for LLC tax classification.

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