Last Updated: February 13, 2024
A Limited Liability Company (LLC) is a business structure renowned for its tax flexibility. When establishing an LLC, you can choose the way that it‘s taxed; by opting to have your LLC taxed as S corp, you can do a lot to advance your company. Read on to find out what the benefits of owning an LLC and having it taxed as an S corp are!
How Is an LLC Taxed?
United States law doesn’t regard LLCs as separate taxable entities, meaning that the LLC owner is responsible for determining the tax status of the company. There are multiple ways that an LLC can be taxed, such as a single-member LLC, multi-member LLC, an S corp, or a C corp. Since owners can choose the way their company is taxed, Limited Liability Companies are among the most popular types of businesses; an LLC filing as an S corp is one common occurrence.
The basic taxation principle of LLCs is pass-through taxation: the company’s income is reported on the personal income tax return of the LLC’s owner based on their share in the company. However, local and state governments may impose additional taxes on LLCs, meaning they would be obliged to pay federal income tax on their company’s profits.
An LLC tax classification often depends on the number of owners or members operating the LLC, as well as the location of the company and the extent of its operations.
|DID YOU KNOW? LLCs are among the most popular types of businesses in the US – if you’re thinking about starting your own business, you can read this article on how to start an LLC.
S Corp Taxation
An S corp is a pass-through entity that passes its corporate income, losses, and deductions through shareholders for tax purposes; each shareholder has to pay income tax on their share of the profits. S corps have the benefit of limited liability, which means they’re exempt from double taxation.
There are certain requirements a company must meet in order to qualify for an S corp tax status. The number of shareholders can’t exceed 100, and companies can’t be classified as partnerships, corporations, or owned by non-resident aliens. The LLC S corp election can be done by filling out a form 2553, which allows a company to be taxed as an S corp. If an LLC elects for this tax status, it can save money on employment taxes by distributing profits to its members and any passive shareholders.
LLC members and owners that have an active role in business operations are regarded as S corp employees and they have to receive a ‘reasonable salary’ that is determined based on their position and role. The S Corp election for an LLC means that the rest of the company’s profits are distributed among shareholders as dividends. Another benefit of an S corp status is that LLC members don’t have to pay self-employment tax (SECA tax) on the amount they receive as income from the company.
The Difference Between an S Corp and a C Corp
LLC members can also choose to have their LLC taxed as a C corp. The legal status of the company won’t be changed to a corporation, but you can choose to have it taxed as one for various reasons.
If LLC members choose this option, they have to pay corporate taxes on their earnings at the current flat rate of 21%. All remaining profits are distributed among the members from the after-tax funds.
S Corp vs C corp tax advantages are evident in the fact that S corps don’t have to pay federal taxes on the majority of their earnings, and they can freely distribute company gains among shareholders. If S corps want to use these tax advantages to their benefit, though, they have to comply with strict regulations imposed by the IRS – no more than 100 shareholders, domestically based, no individual investors, and offer only one class of stock.
C corporations don’t have to comply with these rules and they can expand their base of operations, meaning they are usually larger than S Corps.
How Is an S Corp Taxed?
An S corp, short for Subchapter S, files business tax returns on Form 1120-S. In addition to this, shareholders’ losses and profits are reported on Schedule K-1, which is attached to Schedule E of the individual tax return.
Regardless of whether the LLC is taxed as an S corp vs being an actual S corp, the owners have the same tax liability; they have to pay income taxes on their share of the ownership of the company, which is reported on a Form 1040. S corporations are also responsible for paying FICA tax, which includes unemployment taxes, workers’ compensation, Social Security, and Medicare. If the business owns any type of property, property tax must also be paid on the value of the property.
When considering S corp vs LLC tax benefits, you should be aware that some states impose additional taxes on S corps, such as franchise tax, gross receipt tax, and state income tax. Before forming an S corp or filing your company to be taxed as one, it’s a good idea to do some tax planning; check what taxes are required by the state where you’re planning to base your business.
|DID YOU KNOW? Forming a business is often long and difficult – if you’re feeling discouraged about the foundation of your company, turn to one of the top LLC services and have them take care of all the paperwork for you.
LLC Taxed as S Corp: How Does It Work?
S corporations aren’t business entities, but they are considered tax designations that are applied to businesses. It is a practical choice for small businesses to be taxed as S corps; they can opt for this taxation status as long as they meet certain criteria.
When an LLC changes its tax filing status to an S Corp, the company’s income is treated differently by the IRS. If the LLC tax classification is just an S corp, the company doesn’t have to pay taxes on the entire amount of gross income: they can report one half of the income as pass-through earnings, and the other half is distributed as dividends. The Tax Cuts and Jobs Act of 2017 provide S corps another benefit; pass-through businesses have become eligible for a 20% Qualified Business Income Deduction, which can produce additional tax savings. This pass-through deduction is not available for higher-income business owners.
In order to be taxed as a corporation, an LLC owner has to file an Entity Classification Election (IRS form 8832) and a form 2553, Election by a Small Business Corporation. When comparing IRS form 8832 vs the 2553, the difference is that the 8832 has to be signed by all LLC members, or one of them signing on behalf of all the others in an action previously approved by all members. The 2553 doesn’t have any such requirements – one owner can file without the consent of the other owners/members. The names and identifying numbers for all LLC members need to be submitted when filing for a change of tax classification, and to begin the year with this new classification as well. Any LLC taxes filing has to be concluded by March 15.
Can a Single Member LLC Be Taxed as an S Corp?
A single-member LLC is automatically taxed as a disregarded entity: the income from the LLC is reported on the personal income tax return. However, even single-member LLCs can choose to be taxed as an S corp. They still need to meet eligibility requirements, such as having a consent form signed by all LLC members, filing for this change on a predetermined date, and designating a tax year with a clearly stated date that will serve as the beginning of the tax year.
If these requirements are met, an LLC can file for an S corp status and get the most important S corp advantage – no double taxation. In cases where a single-member company becomes an S corp for taxation purposes, the owner can make themselves an employee, pay their reasonable salary, and retain any other profits as distribution. The owner doesn’t have to pay self-employment taxes on income they earn from the LLC.
|DID YOU KNOW? Every LLC has to list a registered agent in the company’s formation documents. If you’re having trouble locating one for your LLC, you can find one here.
|S corp is a tax classification offered by the IRS that can be chosen by corporations and LLCs.
|The S corp status is chosen by filing form 2553 with the Internal Revenue Service.
|S corps allot salaries. Owners don’t have to pay taxes on the entire amount of gross income if the LLC is taxed as an S Corp on a tax return.
|If your company meets all requirements for an S corp, you should consider filing to have the tax status of your LLC changed.
Should I File My LLC as an S Corp?
Before filing for an S corp status, you should carefully consider if that is the best course of action for your business. You should only file for this type of status if:
- Your business is well-established and produces stable profits
- You are familiar with bookkeeping and payroll taxes
- You can afford to pay the ‘reasonable salary’
- You need to have at least $10.000 in annual distributions
Before reaching a final decision regarding the status of your company, you should also be aware of LLC taxed as S corp disadvantages. The rules for filing company taxes are stricter if the company is taxed as an S corp – LLC owners need to adopt a calendar year as the company’s tax year, unless they can list a reason for having a fiscal year. There is less flexibility in allocating income and losses, and the IRS pays more attention to these entities, meaning the chances of an audit are significantly higher. Another disadvantage is that 1099 forms aren’t available for an LLC taxed as S Corp; LLCs taxed as S corps aren’t entitled to non-employment compensation.
If you’re still uncertain as to whether you should file for an S corp status, you can always consult a financial advisor that can help you reach the right decision.
|DID YOU KNOW? A multi-member LLC is, by default, treated as a general partnership – the amount of taxable income they have to pay depends on their share in the company. Even if they don’t have any profits, they still have to report taxes.
Operating an LLC as an S corp for taxation purposes can be beneficial for your business. Before filing the paperwork to change its tax status, make sure that filing as an S corp is the best option for you. The process of changing a company’s status is quick and easy, and you can begin to reap the benefits of S corp taxation almost instantly.
By choosing to be taxed as an S Corp, LLCs can save money on Social Security and Medicare taxes since they are exempt from SECA tax. One of the most important S Corp tax benefits is that they are not subjected to double taxation.
Yes! Even single-member LLCs can be taxed as S corps. The owner can list themselves as an employee and divide profits between their salary and dividends, thus reducing the amount of taxable income.
Tax statuses should always be determined based on the business’s circumstances. Although the S corp taxation system is generally considered to be better, you need to see if it’s the best system for your company before filing for a status change.
Yes, an LLC taxed as S Corp has shared, much like a regular corporation. It’s a plus that the money from shares is not subject to employment taxes, which allows shareholders to keep a larger part of the company’s profits.