Key Takeaways

  • Converting from an S corporation to an LLC or running an LLC as an S corp can offer tax savings, greater operational flexibility, and reduced compliance burdens.
  • An LLC can elect to be taxed as an S corporation by filing IRS Form 2553, allowing owners to split income into salary (subject to payroll tax) and dividends (not subject to self-employment tax).
  • To successfully operate an LLC taxed as an S corp, you must comply with IRS requirements, including paying reasonable salaries, maintaining proper documentation, and limiting the number and type of shareholders.
  • LLCs and S corps share key features like limited liability and pass-through taxation but differ in ownership rules, profit distribution, and formalities.
  • Choosing between an LLC and S corp—or combining their advantages—depends on business size, profit level, administrative capacity, and long-term growth plans.

S Corp to LLC

Changing an S corp to an LLC-based business structure offers many advantages and many similarities that make them both attractive. There are several factors you should consider before you make a final decision on what you want your business to look like.

What is an LLC?

An LLC is a type of business structure that is authorized by statues in different states. It is designed to allow the limited liability protections offered to corporations with the different tax advantages and the flexibility of operations of partnerships and sole proprietorships.

LLCs provide a limit on personal liability of the individual owners much like the protections afforded to owners of corporations. The personal liability is limited to the individual owner’s investment in the business. With regard to taxation, LLCs with only one member are treated the same as a sole proprietorship. LLCs with more than one member are regarded as a partnership.

An LLC may choose to be treated and taxed as a corporation by filing Form 8832. The Entity Classification Election provides this option. Form 2553 for Small Business Corporation can allow businesses to be taxed as an S corporation. Once you set up your LLC, you can choose to have it treated like an S corporation.

What is an S Corp?

An S corporation is a type of corporation that is formed when you comply with state incorporation rules that choose to pass through the company’s income, deductions, losses and credit to the owner of the business for the purpose of taxation. The owners of S corporations will report the income and losses of the business on their own tax returns and are subsequently assessed the tax on personal income tax rates.

The money paid to the owners and the employees will have FICA, Social Security and Medicare withheld from their pay. The other net earnings are passed through to the owners and are considered dividends. Those payments are not subject to SECA tax and are not considered a form of passive income.

If your LLC is operating as an active trade and payroll taxes are high, an S corporation election is an ideal option.

How to Run an LLC as an S Corp

If you’re asking, “How do I run an LLC as an S corp?” the process involves more than just forming an LLC — it requires making a strategic tax election and following specific operational practices. Here’s how it works:

  1. Form Your LLC:
    Start by establishing your limited liability company with your state. This step includes filing Articles of Organization, appointing a registered agent, and creating an operating agreement.
  2. File IRS Form 2553:
    Once the LLC is formed, you can elect to have it taxed as an S corporation by submitting Form 2553 (Election by a Small Business Corporation) to the IRS. This must typically be filed within two months and 15 days of the beginning of the tax year in which the election is to take effect.
  3. Meet Eligibility Requirements:
    To qualify for S corp status, your LLC must:
    • Have no more than 100 shareholders.
    • Have only allowable shareholders (individuals, certain trusts, and estates—not partnerships or corporations).
    • Issue only one class of stock.
    • Be a domestic entity.
  4. Pay Yourself a Reasonable Salary:
    The IRS requires that owners actively working in the business pay themselves a “reasonable salary” for their services. This salary is subject to payroll taxes. Any remaining profits can be distributed as dividends, which are not subject to self-employment tax.
  5. Maintain Corporate Formalities:
    Even though LLCs are generally less formal than corporations, once you elect S corp status, you must follow certain requirements, such as:
    • Running payroll and withholding taxes.
    • Keeping accurate financial records.
    • Holding meetings and maintaining minutes if required.
    • Filing annual reports and complying with state-level requirements.
  6. Distribute Profits Properly:
    Owners receive two types of payments — salary and profit distributions. Managing this correctly is key to retaining S corp status and optimizing tax benefits.

Tasks Associated with Creating and Running a New LLC

There are some things you must do when running an LLC, including the following:

  • Creating your LLC’s operation agreement
  • Contacting customers, clients, and anyone your business works with about your new status of LLC
  • Hold any LLC meetings that are required, such as those with members and managers
  • Maintain the minutes of LLC meetings
  • Do not mix LLC and personal finances
  • Use your official LLC name on all documents your business uses to correspond
  • File all annual reports that are required by your state

Tax Advantages of Electing S Corp Status for an LLC

Operating an LLC as an S corp is particularly appealing for small businesses generating consistent profits because of its potential tax advantages:

  • Reduced Self-Employment Taxes: Standard LLC profits are subject to self-employment taxes. By electing S corp status, only the salary portion is subject to payroll taxes, while the remainder is distributed as dividends free of self-employment tax.
  • Pass-Through Taxation: Like a standard LLC, an S corp avoids double taxation — profits pass through to owners and are taxed only once at the individual level.
  • Potential Retirement and Benefits Opportunities: Because owners receive a W-2 salary, they can contribute to retirement plans and potentially access better fringe benefits.
  • Enhanced Business Credibility: Electing S corp status can make your business appear more structured and stable, which is attractive to investors and lenders.

However, the tax benefits only outweigh the costs when profits are high enough to justify the additional administrative responsibilities and payroll costs.

The Similarities of LLC and S Corp

There are many similarities between LLCs and S corps, including the following:

  • Both offer limited liability protection. In both situations, owners are not going to be held personally responsible for the liabilities and debt of the business.
  • Both are separate entities that are formed by filing with your state.
  • They offer pass-through taxation. S corps have to file a business tax return. LLCs file a business tax return only in the event that the LLC has more than one member. No taxes are paid at the business level with pass-through taxation. All business profits and losses are passed to the owner’s personal taxes. All taxes are paid individually.
  • They are subjected to all formalities mandated by the state, including filing annual reports and fee payments.

LLC vs S Corp

Both LLCs and S corps are similar, but they also have features that may be more attractive than the other.

LLCs are superior to S corporations with regard to administration and operation. It is also better when allocating the percentage of losses and profits between all the members.

S corporations are better than LLCs with regard to flexibility when paying out earnings to the owners in either earned income, salaries or wages. They are also better with regard to tax planning.

When Should an LLC Elect S Corp Status?

The decision to operate your LLC as an S corp should be based on several financial and strategic considerations:

  • Consistent Profits: If your business consistently earns more than the reasonable salary you would pay yourself, an S corp election can save thousands annually in self-employment taxes.
  • Owner Involvement: S corp status is ideal if you actively participate in daily operations and want to split income between salary and dividends.
  • Growth Plans: If you plan to attract investors or add multiple owners, you may want to consider other structures, as S corp ownership restrictions (e.g., 100-shareholder cap) may limit growth potential.
  • Administrative Capacity: S corps require more compliance — including payroll setup, IRS reporting, and stricter recordkeeping. Businesses without the resources to manage these tasks might prefer to remain standard LLCs.

Compare LLC vs S Corporation: Ownership

LLCs are allowed to have as many members they wish. S corps cannot have more than 100 owners. Those who are not residents of the United States can be a member of an LLC. S corps shareholders have to be U.S residents. S corporations may not be owned by a C corporation, a different S corporation, an LLC or any partnerships. LLCs are not tied down in this way.

Common Mistakes When Running an LLC as an S Corp

Many business owners unintentionally jeopardize their tax benefits or S corp status by making avoidable mistakes. Some of the most common include:

  • Paying Unreasonable Salaries: Paying yourself too little can trigger an IRS audit, while overpaying defeats the tax-saving purpose.
  • Ignoring Compliance Requirements: Failing to file Form 2553 correctly or neglecting annual state filings can result in the loss of S corp status.
  • Commingling Finances: Always keep personal and business finances separate, and use a dedicated business bank account.
  • Distributing Profits Improperly: Ensure distributions are proportional to ownership percentages to avoid legal and tax complications.
  • Overlooking State-Level Obligations: Some states have additional S corp filing or franchise tax requirements.

Frequently Asked Questions

  1. How do I run an LLC as an S corp?
    Form your LLC, then file IRS Form 2553 to elect S corp tax status. Ensure you meet eligibility requirements, pay yourself a reasonable salary, and follow IRS compliance rules.
  2. Is it better to start as an LLC or S corp?
    Most businesses start as LLCs for simplicity, then elect S corp status later once profits justify the added compliance and tax savings.
  3. How does an LLC taxed as an S corp save money?
    Owners pay payroll taxes only on their salary, while profits distributed as dividends are exempt from self-employment tax.
  4. Can a single-member LLC become an S corp?
    Yes. A single-member LLC can elect S corp status by filing Form 2553 and meeting ownership and operational requirements.
  5. What happens if I don’t pay myself a reasonable salary?
    The IRS may reclassify distributions as wages and assess back taxes, penalties, and interest.

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