Key Takeaways

  • LLCs are not automatically double taxed—by default, they are pass-through entities, but electing corporate taxation can create double taxation on profits.
  • Double taxation occurs when income is taxed at both the corporate and individual shareholder level, which happens if an LLC elects C corporation tax treatment.
  • S corporation taxation allows an LLC to avoid double taxation while still offering payroll tax savings for owners who are also employees.
  • Choosing corporate taxation for an LLC can offer benefits like potential tax rate advantages, retirement plan options, and retained earnings flexibility.
  • Disadvantages include more complex tax filing requirements, potential loss of certain deductions, and the risk of paying more in total taxes if dividends are issued.
  • IRS rules for making or changing a corporate tax election are strict, with deadlines and eligibility requirements that must be met to avoid penalties.

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 Tax Elections Affect LLC Double Taxation Risk

An LLC’s risk of double taxation depends entirely on its chosen tax classification:

  • Default Single-Member LLC: Treated as a sole proprietorship, all income passes through to the owner—no double taxation.
  • Default Multi-Member LLC: Treated as a partnership, profits pass through to members—no double taxation.
  • S Corporation Election: Avoids double taxation while potentially reducing self-employment taxes for active owners.
  • C Corporation Election: Triggers double taxation if profits are distributed as dividends.

Owners should model projected income, planned distributions, and long-term growth strategy before making an election that could create or avoid double taxation.

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. 

How S Corporation Status Helps Avoid Double Taxation

An S corporation is a pass-through entity for federal tax purposes, meaning profits and losses flow directly to shareholders and are taxed at the individual level only. By electing S corporation status, an LLC can:

  • Avoid the double taxation imposed on C corporations.
  • Allow owners who are also employees to split their income into a reasonable salary (subject to payroll taxes) and distributions (not subject to Social Security and Medicare taxes).
  • Maintain corporate liability protections while enjoying simplified federal taxation.

However, S corporations have strict eligibility requirements, including limits on the number and type of shareholders and the one-class-of-stock rule.

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.

Strategic Benefits of Corporate Taxation for LLCs

Electing corporate taxation for an LLC can be beneficial in certain circumstances:

  • Lower Corporate Tax Rate: The flat corporate tax rate (currently 21%) may be lower than the top individual tax rates for high-income owners.
  • Retained Earnings Flexibility: A corporation can retain earnings for future growth without immediate distribution to owners, potentially deferring some taxes.
  • Expanded Deduction Opportunities: Corporations may offer broader deductions for fringe benefits such as health insurance, life insurance, and retirement contributions for owner-employees.
  • Investment Appeal: Some investors prefer the corporate structure due to familiar governance rules and the ability to issue different classes of shares (for C corps).

These advantages must be weighed against the possibility of double taxation if profits are distributed as dividends.

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. 

Understanding When LLCs Face Double Taxation

While LLCs are often promoted as avoiding double taxation, this benefit depends on how the LLC is taxed. By default, an LLC is a pass-through entity, meaning profits are taxed only once—on the owners’ personal returns. However, if an LLC elects to be taxed as a C corporation, its income is subject to double taxation.

Here’s how it works:

  1. Corporate Level Tax: The LLC, now taxed as a C corporation, pays corporate income tax on its profits.
  2. Owner Level Tax: When those after-tax profits are distributed as dividends to owners, the recipients must report and pay taxes again on that income at their personal tax rates.

The total tax liability can be significant if the LLC distributes most of its earnings. However, double taxation can sometimes be minimized or delayed by reinvesting profits into the business, using deductible fringe benefits for owners, or exploring S corporation election instead.

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. 

Frequently Asked Questions

1. Are LLC double taxed by default?

No. By default, LLCs are taxed as pass-through entities, so profits are only taxed once at the owners’ personal income tax rates.

2. When does an LLC face double taxation?

Double taxation occurs if an LLC elects to be taxed as a C corporation and distributes profits as dividends to owners.

3. Can S corporation status help an LLC avoid double taxation?

Yes. S corporation status keeps pass-through taxation while offering payroll tax savings for owners who are also employees.

4. How can an LLC reduce double taxation risk?

By retaining earnings for reinvestment, providing deductible benefits to owners, or electing S corporation status instead of C corporation taxation.

5. Should high-income owners consider corporate taxation?

Sometimes. A flat corporate tax rate may be lower than top individual rates, but the benefits must outweigh the risk of double taxation.

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