Can an LLC Elect S Corp?
You may not know that as an LLC owner, you can elect to file as an S corporation via IRS form 2553.
An S corporation offers unique tax benefits from a limited liability company. Typically, S corp organizations have 100 or fewer shareholders and gives the business the usual benefits of incorporation with the freedom and tax benefits of an LLC.
An S corp is also known as S corp subchapter, and it is a different type of tax designation than an LLC. When an LLC files taxes as an S corp through Form 2553, it may be able to obtain certain tax advantages that it wouldn’t normally qualify for.
Here is an article about S corporations and how they operate.
How Does an LLC Elect S Corp?
When deciding between filing as an LLC vs S Corp, it’s best to examine your personal tax liabilities and potential savings.
Both LLCs and S corporations are pass-through tax entities. This means that the businesses don’t pay taxes on the entity level like C corporations. Instead, the income tax passes through to the owner(s) of the entities, and they receive exclusive tax benefits for claiming as income as a business rather than an individual.
If you want to be taxed as an S corp, then you’ll have to meet certain criteria:
- Your business must not have greater than 100 shareholders.
- There may be no preferred shareholders among the owners.
- The business must be formed in the United States and owned by individual U.S. citizens.
If you meet these criteria, then you can elect tax treatment as an S corporation. Here’s how:
- File Form 2553. When you file Form 2553, your corporation switches from the LLC and C corporation tax structure to the S corporation structure.
Not all LLCs are able to file as S corps and filing as an S corp can deter investors for business trying to raise capital funding.
You may be subject to certain IRS scrutiny if you elect to file as an S corp. If you elect to become an S corp, you must also divide stock among shareholders. The S corporation’s stock can be preferred or common stock.
Here is an article with more details on an LLC vs S corporation and how to choose the right structure for your business’s taxes.
Should a Single Member LLC Elect S Corp?
A single member LLC owner can elect to file taxes as an S corp, and they may find that doing so carries several benefits. As an LLC owner, you automatically default to a sole proprietorship when paying taxes.
Sole proprietors are seen as self-employed; S corporation owners are not. As a S corp owner, you must show the IRS that you pay yourself a reasonable annual salary. Filing as an S corp can help you save money by avoiding hefty self-employment taxes, including Medicare payments and Social Security contributions.
However, because you’re an employee of the S corporation, you will have to prove that you pay yourself a salary and use the remaining business profit as a dividend to prevent being taxed twice.
A “reasonable” salary in S corporation terms will be relative to your business’s profitability. You are not able to claim all of your income as dividends to prevent paying self-employment taxes, even as a single member LLC.
You might consider using a 60/40 rule, in which you receive 40% of your business’s income as a salary, and the remaining 60% is filed as dividend. However, it’s best to consult with a tax expert and financial adviser before you file as an S corp or claim any income.
Here is an article on how to pay yourself reasonable compensation as an S corp.
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When Should an LLC Switch to S Corp?
An LLC should switch to an S corp when it becomes successful enough that its self-employed tax burden exceeds its burden as another type of corporation.
LLCs with more than one member default to a partnership, but under the S corp tax structure, all shareholders are regarded as employees. Therefore, personal tax liability as a self-employed business owner is lower.
An LLC might switch to an S corp when it wants to transfer assets and liabilities as a self-employed person to an employee-based model. This election by a small business corporation offers unique tax savings, and possibly lower tax burdens overall.
Here is an article about choosing the best time to switch to an S corp.
Does an LLC Electing S Corp Have Stock?
Yes, even a single member LLC has stock if it elects as an S corporation. An S corp only has one class of stock, and it operates the same way as membership interest in an LLC.
The IRS requires all S corps to issue both voting and non-voting stock, but they must all have the same rights to distribution and liquidation.
Keep in mind that any foreign ownership is strictly prohibited for S corporations; you will never be able to sell or trade stock to investors overseas, or anyone in the United States who does not have citizenship. However, foreign individuals who are U.S. residents or citizens can be shareholders.
S corp stock does not allow for preferred investors with unique divided and distribution rights. While this many not affect your business, it’s important to know when attempting to attract investors in the future.
Here is an article with the official IRS web page about S corporation stock and debt.
Benefits of an LLC Electing S Corp
By electing to be an S corp for tax purposes, you can experience several benefits:
- No self-employment taxes. For successful LLC owners, self-employment tax burdens can become a large expense. S corp owners are treated as employees, so you do not have to pay taxes as a self-employed individual.
- Save money on tax liability. By filing as a salaried employee of your S corporation, you can pay less than you would as a self-employed individual. The same applies for all other shareholders of the LLC electing S corp.
- Pay less Social Security and Medicare. Self-employed filers must contribute 12.4% Social Security and 2.9% in Medicare tax; employees filing as S corp members only pay 6.2% of Social Security and 1.45% of Medicare taxes.
- Protect your assets. Creditors will not be able to pursue shareholders’ personal assets (such as homes, cars, and bank accounts) if they are employees of an S corp. Therefore, this model provides a greater level of personal protection than an LLC or general partnership.
Although maintaining an S corp filing status can be expensive, you do so in exchange for greater asset protection and lower personal tax liability.
That being said, filing as an S corporation as an LLC is a complex process. You should always consult with a tax attorney and financial expert before electing S corp on your taxes.
Here is an article with more information on the pros and cons of electing S corp.
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