Key Takeaways

  • A single member LLC vs S corp decision depends on taxation, management flexibility, and compliance requirements.
  • LLCs default to disregarded entity taxation, while S corps allow salary plus distributions to reduce self-employment taxes.
  • S corps face stricter ownership rules: only U.S. citizens/residents can be shareholders, and a maximum of 100 shareholders is allowed.
  • LLCs provide greater management flexibility and fewer formalities compared to S corps.
  • State fees and compliance obligations may differ significantly, impacting long-term costs.

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.

Eligibility Requirements for S Corp Status

Not all LLCs can elect to be taxed as an S corporation. To qualify:

  • The LLC must have no more than 100 shareholders (or members).
  • All shareholders must be U.S. citizens or resident aliens; corporations, partnerships, and most trusts are not eligible owners.
  • The company can issue only one class of stock (or membership interest).

These restrictions mean that while single member LLCs can typically qualify, multi-member LLCs with ineligible members may not be able to make the S corp election.

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.

Drawbacks of S Corp Election

While S corp taxation can save money on self-employment taxes, there are downsides to consider:

  • Stricter compliance requirements: S corps must adopt bylaws, issue stock, hold regular shareholder and director meetings, and maintain meeting minutes.
  • Increased administrative costs: Hiring accountants or legal professionals to ensure compliance can be more expensive than maintaining a single-member LLC.
  • Potential state-level taxes: Some states impose additional franchise taxes or fees on S corps, which could reduce the tax savings.
  • Risk of IRS scrutiny: Owners must pay themselves a “reasonable salary,” and improper classification of income can result in penalties.

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.

Management and Operational Flexibility

One of the biggest differences between a single member LLC vs S corp is the way each entity is managed.

  • LLC Management: LLCs offer significant flexibility. A single-member LLC can be managed directly by the owner without the need for corporate formalities.
  • S Corp Management: S corps must have directors and officers, even if the business is small. Formalities like meetings, board approvals, and recordkeeping are required.

This means that for owners who want simplicity, a single member LLC may be easier to maintain. However, if tax savings outweigh the burden of extra paperwork, S corp status could be worthwhile.

Cost Considerations and State-Level Differences

The choice between a single member LLC vs S corp also depends on state-level fees and regulations. For example:

  • Some states charge annual franchise taxes or high filing fees for S corps.
  • LLCs may also face annual report fees, though these are often less burdensome.
  • In states like California, both LLCs and S corps face minimum franchise taxes, making local regulations a critical factor in the decision.

Business owners should compare both federal tax treatment and state compliance costs before deciding.

Frequently Asked Questions

  1. Is a single member LLC automatically an S corp?
    No. By default, a single member LLC is treated as a disregarded entity for tax purposes. The owner must file IRS Form 2553 to elect S corp taxation.
  2. Who cannot be a shareholder in an S corp?
    Non-resident aliens, corporations, partnerships, and certain trusts cannot be S corp shareholders. Only U.S. citizens or resident individuals qualify.
  3. What is the main tax advantage of choosing S corp status?
    The ability to split income between salary and distributions, which can reduce self-employment taxes compared to LLC default taxation.
  4. Do S corps require more paperwork than LLCs?
    Yes. S corps must follow corporate formalities, including issuing stock, holding meetings, and keeping minutes, while single member LLCs are simpler to manage.
  5. Should I choose a single member LLC or S corp?
    It depends on your goals. LLCs provide simplicity and flexibility, while S corps may reduce taxes if your business generates significant profits. Consulting a tax professional can help determine the better fit.

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