The choice of business structure is one of the most crucial decisions that business owners have to make. Limited Liability Companies (LLCs) and S Corporations (S Corps) are two popular business structures, each with its benefits and considerations. However, what some business owners may not know is that an LLC can choose to be treated as an S Corp for tax purposes. This article delves into the concept of an LLC filing as an S Corp and why a business might choose to do so.
Understanding LLCs and S Corps
An LLC is a type of business entity that offers the owners, known as members, limited liability protection. This means that the members are not personally responsible for the company’s debts and liabilities. Profits and losses from the LLC pass through directly to the members, who report them on their personal income tax returns.
On the other hand, an S Corp is a tax designation that a corporation or an LLC can elect with the Internal Revenue Service (IRS). It also provides pass-through taxation, but with some additional perks that can be beneficial for certain businesses.
Why an LLC Might Choose S Corp Status
The primary reason an LLC might elect to be treated as an S Corp is to save on self-employment taxes.
In a standard LLC, the entire net income of the business is subject to self-employment taxes, which includes Social Security and Medicare taxes. For the year 2021, this tax rate is 15.3% on the first $142,800 of net income, and then 2.9% on anything above that amount.
However, if an LLC elects to be treated as an S Corp, it can pay its owners a “reasonable salary” that is subject to self-employment taxes, and then any remaining profits can be distributed as dividends, which are not subject to these taxes. This can potentially result in substantial tax savings.
How to Elect S Corp Status for an LLC
To elect S Corp status, an LLC must file Form 2553, Election by a Small Business Corporation, with the IRS. This form must be filed by March 15 of the current tax year if the LLC wants to be treated as an S Corp for that year. It’s important to note that not all LLCs are eligible to make this election.
The LLC must meet the following criteria:
- Be a domestic LLC
- Have only allowable shareholders (including individuals, certain trusts, and estates, but not partnerships, corporations, or non-resident alien shareholders)
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (i.e., certain financial institutions, insurance companies, and domestic international sales corporations)
Conclusion
Electing S Corp status can be a strategic move for an LLC looking to reduce its self-employment tax burden. However, this decision should not be taken lightly. It’s crucial to consider the additional administrative requirements, such as payroll tax filings, and restrictions on ownership that come with an S Corp election. As with any significant business decision, it is recommended to consult with a tax advisor or an accountant to fully understand the implications and benefits based on the specific circumstances of the business.
