LLC Taxed An S Corp (S Corp Election)

Can an LLC be taxed as a S Corp?

LLCs offer unparalleled flexibility and protection against liabilities. The IRS permits owners of LLCs to choose a different tax category. This means that, indeed, an LLC can be taxed as a S corp. In fact, for numerous LLCs, opting for S corporation (S corp) tax status is often the most advantageous choice. Transitioning to the tax status of an S corp can be accomplished through a straightforward process. Our Los Angeles corporate attorney discusses the various tax options available for your LLC and provide instructions on how to convert your status so that your LLC is taxed as a S corp.

What are the options for LLC taxation?

You have the flexibility to adjust your tax filing approach at any time after establishing the LLC. A limited liability company can opt for tax classification as a sole proprietorship, partnership, C corporation, or S corporation. Let’s examine each government tax assignment in detail:

1. S Corporation: S corps are taxed in a similar manner to sole proprietorships and partnerships. In a single-member or multi-member LLC taxed as a S corp, the LLC itself does not pay taxes on the corporate earnings. Instead, members report these profits on their tax returns for personal income.

2. C Corporation: Both multi-member and single-member LLCs have the same procedure as C corp taxation. Unlike an LLC with a C corp’s tax model, a limited liability company taxed like a C corp is subject to taxation on its earnings two times. Initially, the IRS levies taxes on corporate earnings. Subsequently, any profits distributed to the owners are subject to tax on personal income.

3. Partnership: LLCs that choose partnership taxation must have at least two members. The limited liability company is not taxed itself; instead, profits allocated to the owners are subject to taxes on personal income.

4. Disregarded Entity Unique from the Owner: This designation applies to an LLC with a single member and is essentially equivalent to a sole proprietorship. The expenses and income of the LLC are treated as those of the business owner. Consequently, profits are reported on the owner’s individual tax return.

Whatever the chosen tax classification, each member is responsible for making quarterly estimated tax payments and any necessary tax contributions for self-emplyoment.

What are the default tax classifications for LLCs?

Since LLCs do not possess their own distinct tax assignment, the Internal Revenue Service automatically designates a category for each business. In the absence of any special filings with the Internal Revenue Service to alter your tax assignment, your company will submit taxes under one of the following categories:

1. Sole Proprietorship (assuming the owner is the sole member)
2. Partnership (if the company has a minimum of two members)

Choosing the Optimal Type of Taxation for a Limited Liability Company

Determining the most suitable tax category for an LLC hinges on factors such as business size, industry, and long-term objectives. Each tax status presents distinct advantages and constraints. Acquiring a thorough understanding of the best tax filing approach for your company can significantly enhance its financial performance.

Partnerships and sole proprietorships often prove effective for small companies. These structures maintain control within a smaller group and streamline the tax filing process. Conversely, attracting investors can be more challenging. For numerous LLCs, it makes sense to be taxed as a S corp. This is because S corporations strike a balance between keeping control and attracting investment.

Larger businesses tend to opt for filing in the form of corporations. While this entails more compliance requirements, they typically experience more rapid growth. C corporations have the capacity to issue many stock classes and receive other business’ investments. S corporations, though more restrictive regarding investor participation, offer the benefit of flow-through taxation. Thus, for smaller businesses that do not require extensive investor participation, it makes sense to be taxed as a S corp.

Should you opt for S Corporation status for your LLC?

When determining the most suitable tax status for their LLC, owners must take into account various factors. Members should consider:

1. Anticipated profits.
2. Whether they plan to divide income among owners or retain it within the business.
3. Employment status (having or intending to hire workers).
4. Benefits extended to both members and employees.
5. State-specific taxation considerations.

Advantages of Being Taxed as a S Corp

While each tax status has its own merits, LLCs that decide to be taxed as a S Corp stand to gain the most significant benefits. The transition from LLC to S corp status offers several key advantages:

1. Preserve LLC Structural Benefits: Despite being taxed as a S corporation, there is no need to undergo a structural overhaul into a full-fledged corporation. You may keep enjoying the administrative ease, which includes fewer record-keeping and formal meeting requirements.

2. Provide Salaries and Wages to Members of LLC: When an LLC is taxed as a S corp, owners have the option to receive wages in addition to S corp dividends. That said, the IRS does subject these earnings to FICA tax as well as additional withholding obligations.

3. Receive Dividends from Company Profits: For LLCs taxed as a S corp, following the disbursement of salaries, the leftover profits are distributed to owners as dividends. As opposed to wages, dividends do not fall under taxes related to self-employment.

4. Access Greater Tax Planning Opportunities: S corporations gain access to strategies and deductions that can effectively reduce general tax liability. Thus, it is beneficial for LLCs to be taxed as a S corp.

5. Skip Double Taxation through Flow-Through Taxation: Unlike C corporations, which are taxed on both corporate earnings and personal income, S corps allow corporate earnings to flow through to members, who are taxed only the one time. It is therefore advantageous for LLCs to be taxed as a S corp.

6. Leverage Flow-Through Tax Deductions: Entities with flow-through taxation may take off as much as twenty percent of their net company earnings from taxes on income. This personal deduction is available to any company owner, regardless of whether they itemize the deductions. Thus, there are significant benefits for LLCs taxed as S corps.

What are considerations for opting for S Corporation status?

Members should be aware that choosing S corporation status for an LLC involves several important considerations:

1. Flow-Through Deduction Eligibility: For LLCs taxed as S corps, one may only be eligible for the twenty percent flow-through deduction if one’s income lands within the IRS-defined thresholds. As of 2023, these limits have been raised to $364,200 for joint filers and $182,100 for individuals.

2. Shareholder Constraints: If your LLC is taxed as a S corp, you are limited to a maximum of one hundred shareholders. In addition, a shareholder cannot be a noncitizen or a business entity.

3. Stock Issuance Restrictions: If your LLC is taxed as a S corp, your LLC is restricted to issuing only a single stock class.

4. Investor Limitations: If your LLC is taxed as a S corp, shareholders must be individuals, as is the case in S corporations. Other corporations or companies are not permitted to purchase stock.

5. Heightened Scrutiny from the IRS: The IRS places increased emphasis on scrutinizing the tax returns of S corporations. For LLCs taxed as S corps, it is crucial to thoroughly review all tax filings to avoid fines and penalties resulting from mistakes.

How is Income Taxed for an LLC?

Income generated by an LLC is subject to taxation according to its designated or selected tax category. Once you have determined your tax status, it is essential to file the appropriate paperwork with the IRS. Here are potential tax situations and the corresponding forms for each:

1. LLC electing S Corporation Status: For the LLC to be taxed as a S corp, it will file 1120S. Every member must report their portion of the earnings using their personal 1040, in addition to Schedule K-1.

2. LLC electing C Corporation Status: The LLC must submit an 1120. This form addresses the corporate tax rate on business earnings. If any portion of the earnings is distributed to the members, each owner will report their portion on a 1040. They also need to file with Schedule B.

3. LLC Partnership filing: The LLC must submit a 1065, outlining each member’s allocation of loss or profit. All members will then report their respective portion of the losses or profits on their personal 1040, in addition to Schedule K-1.

4. LLC operating like a Sole Proprietorship: You must report the business’s expenses and income on your personal 1040, in addition to Schedule C, Schedule E, or Schedule F.

Note: Partnerships and sole proprietors enjoy more flexibility in using their tax identification number (TIN). Corporations need to file with an EIN. Proprietors and partnerships can file with either an SSN or an EIN.

How to Choose S Corporation Status

If you wish to have your LLC taxed as a S corporation, you will need to submit a 2553.

Submitting this form negates the necessity to file an 8832, as is required for C corporations. You have the option to utilize online tax filing or submit the form via fax or mail.

Note: For proprietors contemplating whether an LLC can function as a S corporation, the answer is affirmative. While having an LLC taxed as a S corp can bring about tax benefits, certain owners also seek the structural benefits of an S corp. To determine if this aligns with your best interests, it is advisable to consult with your registered agent and a tax attorney.

When is the optimal time for LLCs to adopt S corporation status?

For an LLC to be taxed as a S corp, from a tax-saving perspective, it is advisable for LLCs to transition to S corporations once their tax on self-employment surpasses the tax liability incurred by filing as a S corp. The majority of LLCs reach this juncture when their net income exceeds $40,000. However, in certain instances, this may occur with as little as $25,000 in net income.

Other considerations include:

1. Salaries: S corporation owners have the ability to draw a salary from their gross earnings. According to the particular industry, this could result in a higher overall income.

2. FEIE: Owners who are eligible for Foreign Earned Income Exclusion can exclude a certain percentage of their salary from taxes on income.

3. State of Operation: Some states, such as New York and California, impose taxes at both the S corporation and individual levels. LLCs that opt for S corporation status in these states may experience reduced tax savings. It is recommended to consult with your registered agent for further insights into your state’s tax regulations.

Harnessing the Power of LLCs with S Corporation Status

LLCs offer a unique blend of benefits that few other business structures can match. They allow owners to blend tax advantages with an efficient organizational framework. Having an LLC taxed as a S corp enables you to strike a harmonious balance between precise management and unparalleled tax advantages.

By making the timely decision to elect S corporation status for your LLC, you pave the way for sustained growth and financial gains for the owners who played a pivotal role in launching your venture. Through a thoughtful evaluation of the advantages and potential drawbacks of this choice, along with the proper filing of paperwork, you position your LLC for enduring success.