Should Your LLC Elect to be Treated as an S Corp?

One of the more recent developments in the toolkit of planners structuring entities is the idea of forming an entity as a limited liability company (LLC) under state law and then making an election under Federal tax rules to have the entity taxed as a "small business corporation", more commonly called a "S Corporation" or "S corp." The main reason for making the S corp election is so that the part of the economic gain of the entity can be treated as the profit of the enterprise rather than wages. Unlike wages, S corp profits are not subject to self-employment taxes.

Is the S Corp Election a Good Idea?

There are pros and cons to consider if you are thinking about electing S corporation tax treatment for your LLC. One the one hand, you get the benefit of having only your wages subject to self employment taxes if the LLC is taxed as an S corporation. On the other hand, your LLC must also comply with all of the ownership rules applicable to S corporations. Those rules include the requirement of a single class of ownership, no non-resident alien members, and no corporations or partnerships as members. Also, as a separate entity, the S corp must comply with all the withholding and reporting requirements of an employer, a task that wasn’t necessary if the LLC had no employees other than its members.

Another factor to remember is that not all states recognize the S election. The tax treatment under state law of an LLC electing S corporation tax status is going to vary from state to state and you should talk to a tax professional who is familiar with your state tax laws before making a final determination to have your LLC treated like an S corp.

Why Not Just Use a Corporation?

If you want your business to be taxed as an S corporation, why not just use a corporation rather than a limited liability company? The principal benefit of using an LLC rather than a corporation is that an LLC is a more flexible entity under state law. Even though you need to comply with the rules applicable to S corporations with respect to ownership, the LLC still offers much more room to design the entity to your own specifications. Using an LLC allows you to eliminate many of the formalities that a corporation must observe to preserve its corporate status. With an LLC, you do not need a board of directors, meetings or minutes , for example.

How Does an LLC Choose to be Taxed as an S Corporation?

To have your LLC receive the tax treatment of an S Corp, you must file an election with the IRS using Form 2553. You must file Form 2553 within the first two months and fifteen days of the beginning of the tax year in which the election is to take effect. If you file it later, your election will be effective for the next tax year.

There has been some confusion in the process with some writers stating that the LLC must elect to be treated as a regular corporation under the IRS’s check-the-box regulations, subsequently followed by Form 2553. That is not the case.

The Final Analysis

If you have a business that generates a nice profit over and above what you would consider reasonable compensation for the services that the owners provide, you may be unnecessarily subjecting the profits to self employment taxes if you are operating as an LLC taxed as a partnership. If you think your business may fit this model, your LLC may benefit from choosing to be treated as an S corporation under the tax laws. There are drawbacks, however, so no decision should be made without discussing your own situation with a qualified professional.

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Some content on the site was written by David K. Staub, a Chicago business attorney and frequent writer and speaker on limited liability companies. The site is for educational and informational purposes only and does not constitute legal advice. The information which is presented here is intended to make limited liability companies easier to understand, but weighing the tax, liability and operations issues requires a thorough understanding of the applicable law and cases. Anyone contemplating forming a limited liability company is urged to obtain proper legal advice.