Filing taxes can be complicated for business owners. If you have an LLC, you may be wondering if you should file as an S corporation. Doing so can provide potential tax benefits, but also comes with additional requirements. This guide will walk you through everything you need to know about having your LLC taxed as an S corporation.
LLCs can elect to file taxes as S corporations by submitting Form 2553 to the IRS, which allows profits to be passed through to the owners’ personal tax returns. This avoids self-employment tax on distributions, but adds complexity such as filing business returns and issuing W-2s. Business owners should carefully weigh the pros and cons of an S corp election for their LLC based on their specific situation.
What is an LLC?
A limited liability company (LLC) is a business structure that combines aspects of partnerships and corporations. LLCs provide owners with limited liability protection similar to a corporation, while allowing pass-through taxation like a partnership or sole proprietorship.
With an LLC, profits and losses pass through to the owners’ personal tax returns. The business itself does not pay income tax. LLCs with multiple members are taxed like partnerships, while single-member LLCs are taxed like sole proprietors.
How an LLC can file as an S Corporation
LLCs have flexibility in how they are taxed. Rather than being automatically classified as a partnership or sole proprietorship, LLCs can elect to be taxed as an S corporation by filing Form 2553 with the IRS. To qualify for S corporation status, the LLC must meet the following requirements:
- Have 100 or fewer shareholders
- Have only one class of stock
- Have shareholders who are only individuals, estates, or certain trusts
- Not have any nonresident alien shareholders
Benefits of an LLC filing as an S Corp
There are several potential tax advantages for an LLC filing taxes as an S corporation. Some of the major benefits are given as:
- Avoiding self-employment taxes: S corporation owners only pay self-employment taxes on their salaries. Any additional distributions aren’t subject to the 15.3% payroll tax.
- Income splitting: S corps allow owners to split income among shareholders. This can lower taxes if owners are in different tax brackets.
- Deductible expenses: S corps can write off certain expenses like health insurance premiums and meals. These deductions aren’t available to sole proprietors.
Downsides of an LLC filing as an S Corp
While filing as an S corp offers tax savings, there are also some drawbacks:
- Increased filing requirements: S corps require separate tax returns and forms like Schedule K-1 for shareholders. This may increase accounting costs.
- Payroll administration: S corps must pay owners reasonable salaries subject to payroll taxes. This may require payroll administration.
- Self-employment tax savings limits: The IRS may reclassify distributions as wages if salaries aren’t high enough.
How to File Taxes for an LLC Taxed as an S Corp
If your LLC is taxed as an S corporation, your business and personal tax filing obligations change significantly. Here are the steps for filing taxes:
- File Form 1120S for the S corporation’s return
- Pass earnings through to owners’ 1040s on Schedule K-1
- File W-2s for any employees, including owner-employees
- Pay estimated taxes quarterly
- File individual returns for LLC members
Overall, filing as an S corp adds complexity but can be very beneficial tax-wise if done correctly. Be sure to work with a knowledgeable tax professional when making the election.
Should Your LLC File as an S Corporation?
Deciding whether to file taxes as an S corporation is an important strategic decision for any multi-member LLC. While electing S corp status can provide major tax savings in certain situations, the additional operational complexity and legal requirements add costs as well.
Evaluating factors like the LLC’s profit level, growth plans, owner salaries, and state taxes will help determine if transitioning to an S corp tax filing makes sense. Business owners should analyze their specific circumstances closely and consult tax professionals to determine if filing as an S corp is advantageous before making the election. Factors such as:
- Profit level: Typically at least $40,000 – $60,000 in profits is needed to benefit from S corp status after accounting for the additional costs.
- Growth plans: LLCs planning to reinvest earnings may prefer C corp status for lower taxes on retained profits.
- Owner salaries: LLC owners who take large salaries may not benefit as much from S corp tax savings.
- State taxes: Some states tax S corps differently – this should be evaluated based on where your business operates.
Again, consulting a tax professional can help you make the best decision based on your specific situation. Weigh the pros and cons carefully.
Maintaining S Corporation Status for Your LLC
Once your LLC is approved for S corporation tax status, ongoing compliance is crucial. Failure to follow all legal and operational requirements could lead to your S corp election being terminated by the IRS. This would result in loss of tax benefits and require back payment of self-employment taxes not previously paid.
To prevent this outcome, be sure to pay yourself a reasonable salary, stick to ownership rules, file returns properly, and hold annual meetings. Or better yet, work with an accountant or tax attorney to ensure your S corporation status remains intact. So in short, if your LLC elects S corp taxation, follow these tips to maintain compliance:
- Pay yourself a reasonable salary based on industry standards
- Stick to allowable shareholder eligibility requirements
- Hold annual meetings and keep minutes
- Issue W-2s and 1099s when required
- File required returns and forms on time
Not following the rules can lead to loss of S corporation status and back payment of self-employment taxes. Hire an accountant or tax attorney if you need help navigating ongoing S corp maintenance.
Filing taxes for an LLC as an S corporation offers many potential tax savings but also adds complexity. Weigh the pros and cons carefully and work with an experienced tax advisor to ensure you remain compliant. With the right planning, an S corp election for your LLC can provide significant tax reduction.
Frequently Asked Questions (FAQs)
Still have questions about LLCs filing as S corporations? Here are answers to some common questions:
How do I make the S corp election for my LLC?
File Form 2553 with the IRS within 2 months and 15 days of starting your LLC. The election is effective on the date you began operations.
Can I switch an LLC between filing as a partnership and S corp?
Yes, you can change your LLC’s tax filing status by filing Form 8832. However, the IRS limits how often you can switch.
What if my LLC has international members?
If an LLC has any nonresident alien members, it does not qualify for S corp status. These members would need to be removed first.
What are the ownership limits for an S corp LLC?
An S corp LLC is limited to 100 shareholders. Those shareholders must be individuals, not other companies or partnerships.
How much salary should I pay myself from an S corp LLC?
The salary you pay yourself should be reasonable based on your position and duties. The salary is subject to payroll taxes.
Lyle Solomon has considerable litigation experience as well as substantial hands-on knowledge and expertise in legal analysis and writing. Since 2003, he has been a member of the State Bar of California. In 1998, he graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, and now serves as a principal attorney for the Oak View Law Group in California. He has contributed to publications such as Entrepreneur, All Business, US Chamber, Finance Magnates, Next Avenue, and many more.