Learn how you can have your single-member LLC be taxed as an S corporation.
The default federal tax status for a single-member limited liability company (SMLLC) is disregarded entity. However, the owner of an SMLLC can elect to have the business taxed as either a traditional C corporation or as an S corporation. An S corporation is a special type of small, closely-held corporation. This article briefly covers SMLLCs taxed as S corporations.
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An S corporation, like a typical LLC or sole proprietorship (but unlike a traditional corporation), is subject to pass-through taxation. In other words, the responsibility for paying income tax passes through the business to you personally.
To elect S corporation tax status, you need to file IRS Form 2553, Election by a Small Business Corporation. You can file an election for S corporation tax status at any time after setting up your SMLLC. However, there are limitations on when the election can take effect. Specifically, your S corporation tax status must become effective within the 75-day period before you file the form or within 12 months after you file it. Electing S corporation tax status means you'll have to file additional tax documents each year, such as Form 1120S, U.S. Income Tax Return for an S Corporation.
Both SMLLCs and S corporations have pass-through taxation. Moreover, being taxed as an S corporation involves more paperwork than an SMLLC. So why would you choose S corporation tax status? The most common answer is: As a way to reduce self-employment taxes while keeping pass-through taxation. As the owner of an SMLLC classified as an S corporation you are not considered a self-employed individual and are not subject to federal self-employment tax. Instead, you are considered to be an employee, and—the key point—you can take some, but not necessarily all, available profits from your company as a salary.
Other SMLLC profit, if any, can be taken as a dividend, which is not subject to any employment-related taxes, nor—unlike with a C corporation—to double taxation. By contrast, all profit from a SMLLC classified as a disregarded entity is subject to self-employment tax. In short, if your SMLLC is classified as an S corporation for tax purposes, you'll avoid employment taxes on money you receive from the company in the form of a dividend.
In light of the fact that, with a SMLLC taxed as an S corporation, you pay employment-related taxes on a salary but not on dividends, you might think that you should just take all your money from the SMLLC as a dividend, and thus avoid paying self-employment taxes altogether. This approach, however, is prohibited. The IRS is very clear that you must pay yourself at least "reasonable compensation."
For various reasons, choosing S corporation status strictly to try to save on self-employment taxes can be a questionable proposition. However, if you're seriously considering this approach, you should check with both a lawyer and a tax expert to make sure your SMLLC is properly organized, meets all IRS guidelines, and that re-classification is financially worth your while.
TIP:
It can be difficult to know when compensation is reasonable. In one important legal case, the court listed nine different factors that might be considered in determining the reasonableness of compensation. Similarly, the IRS currently has a list of ten factors. By way of trying to ensure that compensation will pass muster as "reasonable," some accountants apply a 60/40 rule, where at least 60% (a clear majority) of profit is taken as salary and the rest as a dividend. It can also be useful to check for information on comparable businesses using sources like the U.S. Bureau of Labor Statistics or employment agencies.
EXAMPLE: Simon formed her gourmet catering business ten years ago as an SMLLC. Six years later, he elected to have it taxed as an S corporation. Last year the business did very well and he had a net profit of $100,000. He knows that other people doing the same kind of work normally earn $50,000-$60,000 per year. He also checked with some government websites and his accountant for additional confirmation that $60,000 is a reasonable salary. He then paid himself a salary for the year of $60,000 (making sure to have his SMLLC deduct employer taxes for Social Security and Medicare, and also making sure to pay his own share of those taxes on his personal tax return). Simon took the remaining $40,000 as a dividend—and didn't have to pay any employment taxes on that money.
For additional information on any of the issues covered here, including avoidance of self-employment taxes and reasonable salaries, check irs.gov or consult with a tax professional. For other general information related to taxation of SMLLCs, check out the other tax-related articles in the SMLLC section of this website.
FAQs
To elect S corporation tax status, you need to file IRS Form 2553, Election by a Small Business Corporation. You can file an election for S corporation tax status at any time after setting up your SMLLC. However, there are limitations on when the election can take effect.
Should a single-member LLC elect s Corp status? ›
An LLC owner might benefit from a less lofty Social Security and Medicare tax burden if electing S Corporation tax treatment for their single-member LLC. However, there are other factors to consider, such as the additional tax reporting requirements and possibly more scrutiny by the IRS.
Can a single-member LLC be taxed as a corporation? ›
For income tax purposes, an LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and elects to be treated as a corporation. However, for purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.
How do I get my LLC taxed as an S Corp? ›
An LLC can elect S corporation taxation by filing Form 2553, Election by a Small Business Corporation. It must be signed by all the members and can be submitted by mail or fax.
How to convert single-member LLC to S corporation? ›
To make an LLC to S corp. election with the IRS, you need to file form 2553 Election by a Small Business Corporation. The form must be signed by shareholders and an officer of the company.
Can a single member LLC own an S corporation? ›
However, an LLC would generally not be able to own an S corp. An exception to this rule is if the LLC 1) is a single-member LLC that is treated as a disregarded entity for federal income tax purposes and 2) meets the eligibility requirements to be an S corporation shareholder.
What is the benefit of S corp over single member LLC? ›
One of the main differences between an S corp and a limited liability company is the treatment of self-employment taxes. With an S corp, owners can pay themselves a salary subject to payroll taxes, while the remaining profits are distributed as dividends and not subject to self-employment taxes.
What is a major benefit of electing S corporation status for an LLC? ›
The S corporation is the only business form that makes it possible for its owners to save on Social Security and Medicare taxes. Historically, this has been the main reason S corporations have been popular. Example: Mel forms an LLC to operate his Bitcoin mining business and elects to have it taxed as an S corporation.
How can a single-member LLC avoid taxes? ›
LLC owners can avoid paying employment taxes by making a corporate tax election with the IRS. The members of an LLC can choose to have the company be treated as a C-Corporation (C-Corp) or an S-Corporation (S-Corp) depending on which structure provides the biggest advantage to the business.
Should I elect to have my LLC taxed as a corporation? ›
The S corporation is the only business tax status that lets you save on Social Security and Medicare taxes while avoiding double taxation. An LLC taxed as an S corp offers the benefits of a corporation while also providing flexibility on income treatment.
The LLC can then elect S status, assuming that its members are eligible to hold S corporation stock (Regs. Secs. 1.1361-1(c) and 301.7701-3). The entity normally files the election to be taxed as a corporation on Form 8832, Entity Classification Election , in accordance with Regs.
When to elect S corp status? ›
The election must be filed with the IRS no more than two months and 15 days after the beginning of your corporation's tax year. If you miss filing during this period, then you have two choices: petition the IRS for a waiver of the rule or have the election take effect starting in the next tax year.
Can you pay yourself from LLC to S corp? ›
According to the IRS, you have to pay yourself “reasonable compensation.” The IRS doesn't explicitly set an amount; it just needs to be a typical amount someone doing your work gets paid. If you pay yourself this way, you can elect to be treated as an S-corporation for tax purposes.
What happens when you convert an S Corp to an LLC? ›
The merger is without tax consequences, because it's a merger of two entities, Old S and LLC, that are disregarded for tax purposes. Furthermore, all of the assets, liabilities, contracts, and legal relationships of Old S transfer to LLC and in most circ*mstances no third party consents are required.
Does a single member LLC need to file form 2553? ›
As an SMLLC (single-member limited liability company), taxes can be burdensome if one is paying taxes on all the profits that they receive from their company. However, IRS form 2553 can be filed, which would allow the SMLLC to reap the tax benefits of an S-Corp.
How do I change the tax classification of my LLC? ›
Form 8832 is the IRS form a new Limited Liability Company (LLC) uses to elect how it wants to be taxed or an established LLC uses to change its current tax classification. Most often, the form is used by a newly formed LLC that wants to be taxed as a C-corporation.
When should an LLC become an S corp? ›
From a tax perspective, it makes sense to convert an LLC into an S-Corp, when the self-employment tax exceeds the tax burden faced by the S-Corp. In general, with around $40,000 net income you should consider converting to S-Corp.
Is a single member LLC an S corp or AC Corp? ›
If you run an LLC, it's automatically taxed as a sole proprietorship or partnership, but you can elect to be taxed as a corporation instead. S Corp is the more likely choice for an LLC, while C Corps are usually corporations.
Can a sole proprietor elect S corp status? ›
A sole proprietor is not eligible to file as an S corp. A sole proprietor must first incorporate as an LLC or C corp before electing S corp tax classification.
