LLC Taxed as Corporation

LLC taxed as corporation is one of the three options for taxation. LLCs are pass-through entities where tax liabilities “pass through” to you as well as any co-owners' personal income tax. 

LLCs can be taxed as a sole proprietorship, a partnership, or a corporation. 

Default Taxation for an LLC

Structure of LLC membership determines how income taxes are paid. Sole proprietorship is established if an LLC has one member. A partnership is established if an LLC has more than one member. You are responsible for your share of profit in an LLC on your own personal tax return. 

How S Corporations are Taxed

An S corporation reports their income and deductions. Form 1120S is filed reporting the income, profits and losses, deductions, and tax credits for that tax year. 

In an S corporation, an owner serves two purposes: an owner/shareholder of the corporation, as well as employee.

An owner of an S corporation must receive a salary as well as other compensation and include earnings from the business on their own personal income tax return, pay Social Security and Medicare taxes. The S corporation will need to withhold federal income tax, employment tax as well as pay state/federal unemployment taxes, Social Security, and Medicare for that owner. 

An S corporation is unique in that owners are able to save on Social Security and Medicare taxes. As a result, professionals prefer S corporation set-ups over other partnerships. 

Advantage of the Election to be Taxed as a Corporation

If total taxable income is high, consider NOT including your business in personal taxes. Personal tax rates at the higher end of tax tables are typically higher than the highest tax rate in corporations. 

S corporation status provides a couple of benefits:

  • Double taxation issues are avoided. 
  • Owners are separated from the business as employees with payroll tax deductions deducted from their income.

Disadvantage of the Election to be Taxed as a Corporation

Taxes are not paid on corporation or dividend income. However, if your LLC is taxed as a corporation, you will have double taxation

Your CPA/tax professional can help you with LLC taxes as well as deciding to elect to be taxed as a corporation. 

What Happens to the Old Entity

After corporation status is effective, assets and liabilities of your previous business will be contributed to the new corporation in exchange for corporation stock shares. 

How to Elect S Corporation Tax Status

  • File Form 8832, Entity Classification Election.
  • Elections filed on Form 8832 cannot take effect more than 75 days before the filing date. Elections also cannot take effect any later than 12 months after filing date as per Regs. Sec. 701.7701-3(c).
  • Elections can be retroactive up to 75 days before Form 8832 is filed. 
  • Must be filed on or before the 15th day of the third month following the activation date. This is the earliest date the corporation begins conducting business. 
  • In order to be treated as an S corporation, Form 2553 only is filed. 
  • If the status of the corporation classification is changed, it cannot change again for 60 months after the effective date of the new election date without obtaining permission from the IRS (Regs. Sec. 301.7701-3(c) (1)(iv)).
  • Instructions state the individual's percentage of ownership and the date(s) it was acquired should be placed in the number-of-shares and date-acquired sections of Form 2553. 

Relief for Missed S Corporation Elections

Procedures for relief requests upon missing the election deadline for S corporations have been updated by the IRS in Rev. Proc. 2013-30. 

Electing S Status by LLC Treated as Partnership

When a partnership becomes classified as a corporation and is treated as such, the original partnership contributes all assets/liabilities to the newly classified corporation in exchange for stock. They also liquidate by distributing the corporation's stock immediately to the partners before the close of day BEFORE the election is effective. 

If S corporation elections occur in a timely manner for the first year, it will be so for that year. No intervening period will be necessary for when it was a C corporation (Rev. Rul. 2009-15). 

Potential One-Class-of-Stock Issues

S corporation eligibility requirements state that operating agreements, as well as other documents, comply with the rules of S corporation eligibility when being elected.

An S corporation is not to have more than one class of stock. 

All outstanding shares need to confer identical rights to distribution and liquidation proceeds in order to be considered to have one class of stock. Percentage of ownership is the only allocation allowed in an S corporation. Shareholders must be the same class. The only exception is the ability to hold voting/nonvoting shares. 

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