Can an LLC Be Taxed as an S Corporation?

If you run a significantly profitable LLC, you may find paying self-employment tax more challenging than before. In this case, the S corporation tax election may be worth considering. 

S corporation taxation is one of the most common LLC tax strategies available to high-income ventures. However, you may wonder whether it’s the best option for your business. Read on to know the answer.

Key Takeaways

• An LLC can elect S corporation tax status, although it doesn’t change their operations and taxation structure.
• With the LLC to S Corp election, an LLC can save on self-employment taxes. However, the business must meet the Internal Revenue Service’s eligibility requirements for S corporations first.
• To elect S corporation status, an LLC must file two forms: IRS Form 8832 (Entity Classification Election) and IRS Form 2553 (Election by a Small Business Corporation).
• You may consider making the S corporation election if your LLC earns a high net annual income or reaches certain milestones.
• Mistakes such as following different governing provisions and specifying ineligible trusts may affect the approval of your LLC’s S corporation election.

Can an LLC Elect to Be Taxed as an S Corporation?

An LLC can elect to be taxed as an S corporation. When this election is made, the business pays the FICA tax imposed on owner or employee salaries. Moreover, the LLC’s other net earnings become dividends that aren’t subject to SECA tax. This condition only applies to businesses with owners who actively manage their operations. The dividends aren’t treated as passive income.

The Tax Cuts and Jobs Act also makes electing S corporation status attractive for LLCs. Under this bill, pass-through entities can get a 20% qualified business income (QBI) deduction. Those earning a specific amount of taxable income and paying employee wages are eligible to use this deduction, though. If your LLC elects S corporation status, it can claim the QBI deduction.

Compliance Update

LLCs can claim the QBI deduction if their tax year ends on or before December 31, 2025.

Additional Note

LLCs taxed as S corporations retain their operational and “pass-through” tax structure. In pass-through taxation, each of an LLC’s members receives their share of business income and reports it on their personal tax return. As a result, the company avoids double taxation that applies to C corporations.

Bonus Tip

Get everything you need to know about LLC tax elections, including the S corporation election, from this episode of Wealthy & Wise.

Are There Eligibility Requirements for LLCs?

While LLCs can elect S corporation status, they must meet the eligibility requirements set by the IRS. To qualify for the election and get S corporation tax savings, your LLC must:

• Operate in the U.S.
• Have no more than 100 members.
• Consist of allowable members (particularly individuals, certain trusts, and estates).
• Hold one class of stock or its equivalent for LLCs.
• Not operate as an ineligible corporation. Companies such as certain financial institutions, insurance companies, and domestic international sales corporations can’t elect S corporation status.

How Can an LLC Be Taxed as an S Corporation?

Before electing S corporation status, an LLC must file IRS Form 8832. This filing allows the business to elect to be taxed as a corporation.

Finally, the LLC files IRS Form 2553 to make the LLC to S corp election.

How to File IRS Form 2553 for S Corporation Election

You can file IRS Form 2553 on any of the following periods:

• Within 2 months and 15 days after the beginning of the tax year when the S corporation election will take effect
• At any time during the tax year prior to the tax year when the election will take effect

Compliance Update

The two-month filing period for S corporation elections starts on the day of the month when the tax year begins. It’ll end with the close of the day before the numerically corresponding day of the second calendar month following that month. Otherwise, use the close of the last day of the calendar month.

What Do I Need to Complete Form 2553?

You’ll need the following information to complete Form 2553.

Where Should I File IRS Form 2553?

The IRS recommends that you send or fax the original Form 2553 to one of its service centers. These offices are listed on the agency’s instruction page for Form 2553. LLCs that fax their S corporation election forms must keep the original copy with their permanent records.

When Should My LLC Elect S Corporation Status?

Before deciding whether to elect S corporation status, your LLC should consider the following factors.

High Net Annual Income

If your LLC earns a high net annual income, it can choose to elect S corporation status. The election can make sense when a business generates a net annual income of around $40,000 to $80,000.

Low-income businesses would incur additional costs and complications that outweigh the benefits of S corporation election. This makes regular LLC taxation more cost-effective.

Significant Changes to Your Operations

Your LLC may also consider the S corporation election if it achieves other goals. Hiring and managing employees is one example, and that would require running payroll.

In some cases, S corporation elections may make sense if an LLC is preparing for swift growth or fundraising. Lenders and investors are more likely to fund S corporations.

Learn about the implications of converting an LLC to an S corporation on the NCH blog.

What to Avoid When Electing S Corporation Status

Many businesses that elect S corporation status have faced one or some of the following issues during the process.

Following Different Governing Provisions

Again, LLCs wanting to be taxed as S corporations must meet IRS requirements. However, some businesses fail to meet one of these requirements: holding only one class of stock.

While S corporations or businesses taxed as these entities can hold voting and non-voting shares of stock, they must distribute and liquidate these shares. Most of the time, it’s thought that proportional distributions must be made to shareholders. It’s not the case, as a company’s governing provisions dictate whether all outstanding shares of stock must be distributed or liquidated.

Unlike S corporations, LLCs are governed by an operating agreement. This document is generally written considering that LLCs are taxed as partnerships for federal tax purposes. But if an LLC decides to elect S corporation status, the rules stated in its operating agreement might not apply to the situation. LLCs with S corporation taxation lack the same rights as an S corporation’s shareholders have for liquidations.

Making Late Elections

Late S corporation elections won’t take effect until the following tax year. That period starts on the date specified on line E of Form 2553. But if you can explain why you made a late election, the IRS can grant you relief for it.

Provide your specific reason for failing to elect S corporation status and how you’ve rectified the error on line I of Form 2553 or include both on an attached statement. Late elections can be attached to IRS Form 1120-S (U.S. Income Tax Return for an S Corporation).

Specifying Ineligible Trusts

The IRS states that certain trusts can be part of S corporations, including:

• A grantor trust (a trust owned by a U.S. citizen or resident)
• Electing small business trusts (ESBTs)
• QSSTs

Issues may arise if your LLC owns a trust that’s ineligible for the S corporation election or fails to make another election for ESBTs or QSSTs.

Talk to NCH’s Legal Experts About Trusts

Failing to Obtain Member Consent

If all of an LLC’s members disagree with the venture’s decision to elect S corporation status, the election is considered invalid. You must provide the following information on Form 2553 to prove that LLC members consent to the election:

• The signature of each member
• The name(s), address(es), and TIN(s) of all LLC members
• The date(s) of stock or ownership interest acquisition
• The end date of each member’s tax year
• The LLC’s legal business name and EIN
• The type of election approved by LLC members

Still, some businesses don’t specify the people who must authorize their S corporation election. This mistake makes designating LLC members for the election’s approval important.

Frequently Asked Questions

Can LLCs elect the S corporation tax status?

LLCs can elect the S corporation tax status as long as they meet IRS requirements. But if these entities operate as certain types of corporations, they’re ineligible for S corporation election. Examples of unqualified corporations include financial institutions such as banks and insurance companies.

Can a single-member LLC elect S corporation status?

Yes, a single-member LLC can elect S corporation status. It only has to meet the eligibility requirements set by the IRS. A single-member LLC taxed as an S corporation can reduce self-employment taxes, although it may have to run payroll and file an S corporation tax return.

How much money can I save by electing the S corporation status?

Tax savings depend on your LLC’s net earnings and whether you take a reasonable salary.

Generally, the SECA tax for self-employed individuals doesn’t apply to your LLC’s other net earnings. That’s because those profits are considered dividends. Meanwhile, the FICA tax is imposed on owner and employee salaries.

When should I file Form 2553 for an S corporation election to take effect?

You should file IRS Form 2553 within any of these periods:

• Within 2 months and 15 days after the beginning of the tax year when the S corporation election will take effect
• At any time during the tax year prior to the tax year when the election will take effect

If you miss any of these deadlines, your S corporation election won’t take effect until the following tax year.

Does my LLC need to change its operating agreement after electing S corporation status?

Your LLC may need to change its operating agreement after electing S corporation status.

As we’ve mentioned, S corporation taxation doesn’t grant LLCs a shareholder’s right to liquidate their shares in a corporation. To avoid this issue, have a trusted lawyer or tax advisor review your operating agreement before making the election.

Can S corporation elections come with additional expenses?

Yes, S corporation elections can come with additional expenses. They include:

• Full-service payroll costs
• Accountant fees for tax planning and compliance
• Loss of the QBI deduction on the portion of your income paid as salary

What happens if my LLC is ineligible to be taxed as an S corporation?

If your LLC is ineligible to be taxed as an S corporation, it won’t be able to elect this tax classification. This means the business will continue to be taxed as a disregarded entity (for single-member LLCs) or a partnership (for multi-member LLCs). You still get pass-through taxation without the potential savings on self-employment taxes for an S corporation.

What happens if I’m not able to pay myself a reasonable salary?

If you’re not able to pay yourself a reasonable salary, you may want to reconsider electing S corporation status. You should wait until your business earns enough to support salary payments and business operations.

Can an LLC’s S Corporation election be revoked?

Yes, an LLC’s S corporation election can be revoked. Your intent to do so should be declared on a statement of revocation that’s sent to your IRS service center. The information needed for the document includes shareholder names and addresses, your company’s EIN, and the type of election to be revoked.

When can I revoke my LLC’s S corporation election?

You can revoke your LLC’s S corporation election by:

• The 15th day of the third month of your LLC’s current tax year, or 
• The company’s requested effective date

Expert Tips From NCH

1. Determine your LLC’s net annual income before electing S corporation status. The election can make sense when your net annual income stands at around $40,000 to $80,000.
2. Set a reasonable salary and support it with thorough documentation. Research comparable positions in your industry and geographic area, then document your findings.
3. Consider electing S corporation status if your business is preparing for rapid growth. This can be done as your LLC generates more income.
4. Set up proper payroll systems before your LLC is taxed as an S corporation. Don’t wait until your tax year ends to start payroll processing, make tax deposits, and practice proper record-keeping.

Make the Best Decision for Reduced Taxable Income

S corporation election is an LLC tax strategy that offers potential savings on self-employment taxes. However, it may not be the best option for your business. The election generally works best for high-income LLCs, as they can handle the additional compliance requirements associated with S corporation taxation.

If you own an LLC and you’re considering electing S corporation status, NCH can help you understand its advantages and plan for the switch.

Consult Our Tax Advisors Today

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.