1. S Corp Tax Election for an LLC
2. Benefits of S Corp Tax Election
3. Differences Between an S Corp and Single-Member LLC

A single member LLC S corp shareholder is the only owner of a limited liability company that has elected to be taxed as an S corporation. This is a small business entity that provides limited liability protection for owners (known as members) and is subject to beneficial pass-through taxation.

S Corp Tax Election for an LLC

With this type of business structure, the LLC does not pay income tax at the corporate level. Instead, profits and losses are reported on the owner's individual income tax return. An LLC can file IRS Form 2553 to elect S corp tax status. This can be done at any time after establishing an LLC. However, it will take effect either within 75 days before you file the form or within 12 months after. LLCs that opt for S corp taxation must annually file Form 1120S, U.S. Income Tax Return for an S Corporation.

Benefits of S Corp Tax Election

Although S corps must adhere to more requirements than LLCs do, many small business owners choose this entity to reduce self-employment taxes while retaining the benefits of pass-through taxation. With S corp taxation, members are considered employees and can take a portion of profits as salary. Additional profit can be taken as a dividend, which is not subject to employment tax.

However, it's important that the salary you pay yourself as an employee is considered reasonable by the IRS. Otherwise, they may reclassify dividends as salary, which will increase your tax burden. The IRS uses 10 factors to determine whether the compensation you take as an employee is considered reasonable. Many accountants recommend taking at least 60 percent of the company's profit as salary and the rest as a dividend. You can also review data from the Bureau of Labor Statistics for comparable businesses.

LLCs that do not opt for S corp taxation are classified by default as a disregarded entity by the IRS and thus subject to self-employment tax. To determine the best option for your company, review your options with an accountant and a lawyer to ensure you adhere to IRS guidelines.

Differences Between an S Corp and Single-Member LLC

If your S corporation is purchasing a new business or expanding into another state, you may want to create a separate legal entity to separate assets and liabilities. One option is to create a new S corporation to be owned by the same shareholders, known as a brother-sister subsidiary. However, this requires you to file a separate tax return for the new entity. Instead, you could opt for a parent-subsidiary structure with centralized financial and operational functions. This can be done using either a single-member LLC or a qualified subchapter S subsidiary (QSub).

A QSub is a domestic corporation that can elect for S corp treatment. This type of entity:

  • Is completely owned by another S corporation
  • Is not treated as a separate corporation by the IRS
  • Has assets, income, liabilities, deductions, and credits that are treated as those of the parent S corp
  • Is not required to file a separate federal income tax return

A single-member LLC is treated as a disregarded entity and is not treated as a separate tax entity. Because it is so similar to a QSub, it's important to understand that a QSub must be wholly owned by the S corporation. If ownership drops below 100 percent, the subsidiary will be treated as a C corp by the IRS and subject to double taxation.

Conversely, if single-member LLC ownership drops below 100 percent, the subsidiary is treated as a partnership by the IRS and does not risk C corp tax treatment. Pass-through taxation is retained and the LLC will file Form 1065 each year, U.S. Return of Partnership Income.

In addition, an S corporation can own all or partial interest in an LLC. This makes the S corp an LLC member. Although strict rules about who can own stock in an S corp exist, the same rules do not apply to assets that can be owned by the corporation. While a multi-member LLC cannot own shares in an S corp, a single-member LLC can if the single member qualifies as a shareholder.

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