Should My LLC be Taxed as an S Corporation and Why?

It has become customary for many businesses to set up a limited liability company (LLC). Especially when it is a 1 or 2-person business.  Among the many advantages of LLCs are simple default tax classifications: sole proprietor for 1 member, partnership for more than 1 member, also known as “pass-through.” This is the same regardless of the type of member. However, have you asked your lawyer, accountant, or business advisor if it makes sense to simply take the default classification? Small businesses should consider whether making the election to be treated as a “S-corporation” makes sense.

What is an LLC?

The LLC is a type of business structure in which the owners, called “members,” enjoy limited liability from the business’s obligations up to the amount they have invested. An LLC is a legal person/entity separate from its owners and provides many benefits of a corporation without some of the strict operational requirements.

What is a corporation?

The corporation is the most common business structure. Owners, called “shareholders,” also enjoy limited liability. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. The profit of a C corporation is taxed to the corporation when earned and then to the shareholders when distributed as dividends, creating a double tax.

In contrast, S corporations elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. This allows S corporations to avoid double taxation on corporate income. S corporations are responsible for taxing certain built-in gains and passive income at the entity level.

However, only corporations that qualify, can make this election. To qualify, the corporation must meet the following requirements:

• Be a domestic corporation
• Have only allowable shareholders
  -> May be individuals, certain trusts, and estates and
  -> May not be partnerships, corporations, or non-resident alien shareholders
  -> NOTE: an LLC can be eligible to hold stock in an S corporation only if it’s a single-member LLC taxed as a disregarded entity by the IRS. The owner of the disregarded entity is considered the owner of the S corporation stock. However, if the LLC has multiple members, is taxed as a C corporation, or the sole member is a corporation or partnership, it cannot own stock in an S corporation.
• Have no more than 100 shareholders
• Have only one class of stock
• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
• To become an S corporation, the corporation must submit Form 2553,

KEY CONCEPT:

How is an LLC different than an S Corporation? 

S corporation status may be desired because a partner in a partnership is subject to self-employment tax on his or her distributive share of the partnership’s income. In contrast, the S corporation owner is not subject to self-employment tax on his or her passthrough income or distributions from the S corporation. 

Should I elect S Corp. status for my LLC?

If you are unsure about the benefits or the choices discussed above, feel free to contact us by email or by calling 1-866-734-2568. For over 27 years, we have guided business owners in this important depiction-making process.