LLC with S Corp Election

LLC with S corp election refers to when a limited liability company (LLC) chooses to be considered as an S corporation (S corp), which can offer distinct tax advantages.

The LLC is the newest business form, with a high advantage in flexibility where taxes are concerned. When one is running an LLC, they can be taxed in several ways, which allows them to save money both in their business and as their owner. That said, LLCs tend to remain with the default tax form, and some find electing the S corp status can be more advantageous still.

Differences Between LLCs and S Corporations

LLCs and S corps are two of the most common small business legal structures, and many entrepreneurs struggle with which form best suits their needs, as both have their advantages.

For instance, both LLCs and S corps are not taxed for their profits—the taxes are passed on to the owner(s). Also, both forms give the owner(s) liability protection by separating them from their business. However, there are several key differences in advantages that must be highlighted.

LLC taxation advantages include:

  • Fewer state forms and filings, documentation requirements, and formal meetings.
  • Lower start-up costs.
  • More flexibility for profit and loss allocation amongst owners. Percentage of profit distribution can be raised and lowered as you see fit.

S corp taxation advantages include:

  • Greater flexibility in earning distribution to owners. Earnings can be divided into wages and salaries or into distributions, which are considered passive income.
  • FICA tax for Medicare and social security only applies to wages and salaries. (However, you must give yourself a reasonable salary: taking a $20,000 salary and $150,000 distribution is not allowed.)

Also, it should be noted that in an LLC the owner is not considered an employee for tax purposes, while in an S corp the owner is, so long as they perform more than minor duties. For this reason and others, a small business owner has much to consider.

Taxation for LLCs and S Corporations

One of the major differences between LLCs and S corps is how they are taxed. When it comes to LLC taxation, the following key qualities must be considered:

  • LLCs can choose to be taxed as C corps or S corps by filing an election document with the IRS. This makes the LLC the same as a corporation in the IRS’s eyes with the same tax requirements.
  • If no election is filed, LLCs are taxed as single-member or multi-member LLCs, in what is called the “default” status by the IRS.
  • Single-member LLCs are taxed as sole proprietorships, with the owner filing a Schedule C form.
  • Multi-member LLCs are taxed as partnerships. They file Form 1065, and individual partners file Schedule K-1 forms.

Meanwhile, for S corps, the following qualities apply:

  • S corps are considered pass-through entities, meaning losses and income pass through them to the owners in their personal tax returns.
  • S corps report income as deductions.
  • S corps file Form 1120S reporting yearly deductions, income, losses, profits, and tax credits.
  • A Schedule K-1 must be filed by shareholders listing their shares of items on Form 1120S.
  • S corp owners/employees are required to report S corp earnings on their Form 1040 and pay their share of Medicare taxes and social security as part of any employee salary they are paid.
  • S corps with larger circulation will not need to pay as high employment taxes.
  • S corps are required to withhold employment tax and federal income from the owner/employee’s pay, as well as pay federal and state unemployment taxes, Medicare taxes, and Social Security on the employee’s behalf.
  • S corps are the only form of business that allow owners to save on Medicare and Social Security taxes.

How to Set Up an S Corporation

If you decide that an S corp election is the best fit for your business, setting up an S corp is relatively simple. All you need to do is file Form 2553 with the IRS within 75 days of the date of your company’s incorporation. However, to elect S corp status, the following is required:

  • That there are no more than 100 shareholders.
  • That all shareholders are U.S. residents.
  • That all shareholders are individuals, not corporations or partnerships.
  • That the stock is of one class only.

If these criteria are met, then you may continue with the process. Then, once done, you will be able to enjoy all the benefits an S corp designation can bring to your business.

If you need help setting up your LLC with S corp election, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.