Yes. An LLC can be taxed as an S Corp, assuming it qualifies for S Corp taxation status. An LLC can also be taxed as a C Corporation.
An LLC is a very flexible business type because it can be taxed as a corporation or S corp.
Option 1: LLC electing to be treated as a Corporation
A. Single Owner LLC:
If the LLC has only one owner, the IRS will automatically treat the LLC as if it were a sole proprietorship (a disregarded entity), unless an election is made for it to be treated as a corporation. An LLC may elect corporate tax treatment using IRS Form 8832 (Form 8832 Entity Classification Election).
B. LLC Owned by More than One Person:
If the LLC has two or more owners, the IRS will automatically treat the LLC as if it were a partnership unless an election is made for it to be treated as a corporation. An LLC may elect corporate tax treatment using IRS Form 8832 (Form 8832 Entity Classification Election).
Option 2: LLC electing to be treated as an S Corp
An LLC may elect S Corp tax treatment by filing IRS Form 2553 (Form 2553 Election by a Small Business Corporation). However, sometimes the LLC must file both Form 8832 (see Option 1 above) and Form 2553. To determine whether your LLC can file Form 2553 alone, or whether Form 8832 must also be filed, see page 1 of the Instructions to form 2553 or talk with an LLC attorney in your state.
Tips for an LLC Taxed as an S Corp:
Electing to have your LLC taxed as an S Corporation involves a couple procedural changes in paying and filing your taxes.
1. Quarterly Filings for an LLC Taxed as an S Corp
Keep in mind that if your business is treated as an S Corp, it must pay estimated taxes. But this inconvenience is often offset by the tax benefit of an S Corp (self-employment tax savings).
2. Income Taxes at the End of the Year
Also, an S Corp must file different income tax forms at the end of the year (Which Forms Must I File?).
Shareholder-employees will receive two tax documents from the S-Corporation at the end of the year: a W-2 wage statement (income as an employee) and a Schedule K-1 statement (income as an owner).
3. No Self-Employment Tax for an S Corp Owner-Employee
Shareholder-employees of an S-Corp (including an LLC taxed as an S Corp) do not pay Self-Employment Tax because their wages are reported on a W-2, with Social Security and Medicare taxes already withheld. By contrast, the owner of an LLC that is taxed as a partnership or sole proprietorship (not an S Corp) does pay Self-Employment Tax. Self-Employment Tax is figured at the end of the year on Schedule SE of IRS Form 1040.
{ 22 comments… read them below or add one }
Would there be any problems with creating an S-Corp as a holding company for an LLC, both of which would originally be owned by one person? If so, would the LLC be obligated to any of the limitations imposed on the S-Corp? The reason that I ask is that I’m working on starting a CPA form which will initally be only me, but if all goes well I would like to add other owners. I’d like to have the employment tax advantages of the S-Corp without the limitations of ownership and percentage of profit distribution issues.
Great article. Does there need to be a new set of books? Additionally, there isn’t a transfer of assets from one entity to another (taxable or tax-free section 351) since the entity never changed only how it’s taxed, correct?
Thank you.
Marie
Carl:
An S Corp can own all or part of an LLC. An LLC owned by an S Corp is still treated by law as an LLC, not an S-Corp. However, I am not sure how this would be a benefit. The entities must still be treated as separate. Normally, this means the entities would not share employees, operations, or assets. That is, the S Corp’s role would be that of an member of the LLC, which includes a right to distributions of profits.
Aaron
Marie:
When an LLC elects to be taxed as an S Corp, it would not create a new set of financial books. Further, there is no transfer of assets because the entity is still the same entity, it is merely treated differently by the IRS.
Aaron
Can an LLC which has elected to be taxed as an S-Corp have different classes of members?
Heather:
No. An LLC that has elected S-Corp status may not have different classes of members. The IRS’s restrictions on S-Corps apply to LLCs that are taxed as S-Corps.
Aaron
With regards to an LLC taxed as an S-Corp, does the entity follow LLC rules or S-Corp rules when dealing with the death of a member/shareholder, liability issues and other differences in LLC vs S-Corp rules? I have an issue in which a shareholder (LLC) died and there was a large liability in the entity- does this liability pass through to the deceased shareholder’s estate or remain within the entity? Does the spouse of the deceased shareholder receive the ownership interest? Thanks!
Doug:
When an LLC is taxed as an S Corp, the LLC still follows LLC law with regard to its internal operations and rights and duties among its owners. Regarding your second and third questions, these questions would be resolved by analyzing agreements among the owners and LLC law in your state. Thus, an attorney in your state would be needed to answer these.
Aaron
I am trying to start a dealership. Which is teh best legal figure from a legal perspactive, cost and tax perspective. An LLC taxed as an S coorporation or a plain “S” corp. Why? I really appreciate your answers.
Elizabeth:
From an IRS and tax perspective, it doesn’t matter if your business is an actual S Corp or an LLC taxed as an S Corp. However, the type of business entity you choose will matter if the business has multiple owners. State law treats an LLC different from an S Corp in many ways. The differences will depend on your state’s laws. If your business has only one owner, it won’t matter. If a business will have multiple owners, the owners should consult a business attorney in their state regarding the best entity type for their circumstances.
You may wonder which entity type is best for a dealership. There is no one right way. It depends on the circumstances.
Aaron
Aaron-
If the sole member of a Minnesota LLC, treated as a disregarded entity and owning real estate, dies, is the real estate or the llc interest included in the deceased member’s taxable estate? Thank you,
Eric
Eric:
The IRS treats the real estate like it was owned by the deceased owner directly because the IRS disregards the entity. Thus, the real estate is part of the taxable estate. Keep in mind that depreciation and recapture may require some analysis.
Aaron
I have an LLC that is taxed as an S-Corp. There are currently two members and a third person wants to invest as a silent partner. We thought the easiest thing to do would be to issue shares of stock with him having a much smaller amount then the original two members. After reading your blog about following LLC laws rather than S-Corp laws, I’m wondering, can we even do that or do we need to add him as a member with a certain percentage of ownership??
I am a sole member of a startup LLC and have elected to be taxed as an S-Corp, From what I understand, that means that for any profit that I’m not allocating to myself as a disbursement, I should pay myself in the form of a wage. I think that if I pay myself a wage for “reasonable services,” the LLC must pay withholding tax on a quarterly basis. Is this correct so far? Also, what if I’m still operating at a loss and want to defer compensation to myself? Do I still need to pay withholding tax now even though I haven’t paid myself anything yet and am operating at a net loss?
Thanks for any help you can offer.
Tony:
First, here is a little background:
If you elect to be taxed as an S Corp, you must withhold and pay taxes on a quarterly basis (instead of at the end of the year). You withhold and pay taxes on your salary, which must be a “fair market” wage for a person in your position in a similar company. The remaining profit to the business can be paid out as a distribution/dividend, which is only subject to your usual income tax rate (social security, etc. are not withheld from it). The idea is that your income as an employee is taxable like any other employee, but your income as an owner (the profit after all employees are paid) is taxable as though you were just an owner of the business.
Now, to answer your question:
No wages are required until your business can afford to pay you. Your don’t have to withhold taxes because you aren’t paying yourself wages (but you may still be required to file—ask your CPA). First, you should have the business repay any loans to you, then you must take wages, and finally, any remaining profit can be paid to you as profit distributions/dividends.
Aaron
How do you report the equity in an LLC who has elected S-corporation Status? Typically you would have Common Stock and Retained Earnings in a Corp, but in an LLC you have Member Equity because there isn’t stock.
Hello Aaron,
I own a single owner LLC. What are the benefits of electing to be treated as an S-corporation by filing form 2553?
I am not making any money yet, I am currently setting up structures and buying equipment. I live in Ohio.
Michael:
This topic is fairly complex. However, here is the short answer: The main benefit to electing S Corp treatment is that the owner will not have to pay self-employment tax on income that exceeds the owner’s salary. For example, if an owner’s salary is $40,000, and the owner is paid her $40,000 salary in addition to $60,000 in profits in a year, under an S Corp the $60,000 would not be subject to the self-employment tax but in an LLC it would.
Aaron
Aaron – If you have an LLC taxed an S-Corp, do the shareholder restrictions for an S Corp besides the prohibitino on more than one class of stock apply? Specifically the limitations on trusts as owners of S Corp stock? I am trying to find a way to go from S Corp to entity taxed as partnership (or S Corp) without the income tax ramifications of liquidation in order to put the stock (or future membership interest) in testamentary trust without the two year limit. Any thoughts?
Thanks, from Raleigh, NC
Andrea:
That’s a great question. Off the top of my head (without researching it), I’m not sure.
Aaron
Aaron:
I just recently filed (8/18/2010) for an LLC in California. The company will be owned by myself and four other people. However, only I will be provide capital investments toward the company. I would also like to take a wage because I will be running the business and doing all the work. However the four other owners (all legal residents) still want to enjoy tax benefits of owning a business. Should I keep the LLC and file as an S Corp? I will be the only employee seeking a wage but do plan on having employees in future. Or should I just not do the LLC, form an S corp and have them be shareholders. Im just really confused.
Brent:
Keep the LLC. Ask your CPA how much you could save in taxes, if anything, by having the LLC elect to be taxed as an S Corp.
Aaron
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