Electing S Corporation Status for an LLC

S election for LLC allows a business owner to establish a limited liability corporation that receives the tax treatment of an S corporation rather than that of a partnership. This strategy may allow owners to avoid self-employment tax on their shares of income, which is not charged on S corporation distributions.

Electing S Status for a Corporate Entity Under Check-the-Box Rules

Check-the-box rules allow an LLC to opt for corporate tax treatment. Making this election indicates that the LLC transfers all assets and liabilities to a corporation in exchange for stock, which is then liquidated and distributed to the LLC members. This is treated as a tax-free transaction if the LLC has more assets than liabilities. If the LLC members are eligible to hold S corporation stock, the LLC can go on to elect S taxation status by filing Form 8832, Entity Classification Election

A new S corporation must elect for S taxation by the 15th day of the third month after the date on which they obtain shareholders or assets and/or begin conducting business. The entity can do so by filing Form 2553 and will not have to subsequently file Form 8832 if this is done within either 75 days or two months and 15 days after the effective date of S election (whichever comes first). However, S election should not occur before the corporation is conducting business or acquires assets or shareholders.

An entity will be treated as an S corporation from the date of election until it opts for a different classification, which cannot be done within 60 months of S corporation election unless the IRS provides special approval.

Potential One-Class-of-Stock Issues

For an LLC to elect S taxation status, its operating agreement and other documents must follow S corporation requirements. This may require replacing or amending previous documents. For example, an LLC that allows income or loss to pass through to its owners via special allocation would be considered to have more than one stock class and would therefore be ineligible for S corp status

The LLC must distribute liquidation proceeds based on ownership percentage without regard to voting rights and other factors. However, the LLC treated as an S corporation can offer both nonvoting and voting shares. The IRS has not yet ruled on whether limited partnerships taxed as corporations are considered to have more than one class of stock.

The Best of Both Worlds

Establishing an LLC and electing for S corp taxation treatment allows business owners to enjoy the benefits of both entities. This is often an ideal strategy for businesses with high payroll taxes or an active trade. Both business entities provide limited liability protection and offer pass-through taxation in which business income and loss is reported on the owner's individual tax return. An LLC is easier to administer than an S Corp and offers more flexibility in allocating profits and losses to its members. However, an S Corp allows owners to receive either salaried wages or earned income distributions. It also facilitates tax planning.

LLC: Limited Liability and Flexibility

An LLC is governed by state statutes and designed to provide the same limited liability as a corporation with the flexibility and tax advantages of a general partnership or sole proprietorship. With an LLC, each owner reports profits and losses on his or her individual tax return. This allows the members to avoid the double taxation that affects corporation owners. 

Like a corporation, an LLC limits the personal liability of each owner to his or her initial capital contribution. In a general partnership or sole proprietorship, each member is liable for all debts and financial obligations of the business. An LLC can opt for treatment as a partnership, sole proprietorship, or corporation for federal tax purposes. 

S Corporation: Planning and Compensation Options

To form an S corporation, owners must follow the state guidelines to establish a corporation and then submit Form 2553 to the IRS to elect taxation as an S corporation. With this election, the business credits, deductions, losses, and income pass through to the owners' individual tax returns. This allows them to be taxed at the individual rate and avoid double taxation.

If you need help with establishing S corporation election for your LLC, 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 Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.