How to elect S Corp taxation for your LLC
This guide explains the steps on how to elect S corporation tax status with the IRS for an LLC.
BackgroundNew business owners often do not realize that they have options about how their business will be taxed. IRS regulations have default rules, but those regulations also allow businesses to "check-the-box," which means that business owners can file elections with the IRS to be taxed by another method. One particularly popular election is where LLCs choose to be taxed as S corporations. By default, the owner of a single person LLC will be taxed as a sole proprietor, and where an LLC has two or more owners, the LLC will be taxed as a partnership. By making an S corporation election, those owners can maintain the relatively relaxed corporate structure of an LLC, while also reaping the benefits of S corporation taxation -- namely, avoiding excessive self-employment taxes. This article will explain the steps on how the owners of an LLC can make such an election. The article assumes that the business has already been set up as an LLC, can qualify for S corporate treatment under the IRS's guidelines and that the S corporation election is timely filed (more on that below).
Step 1: File Form 2553 With the IRSOwners should file Form 2553, which informs the IRS that the business is electing to be treated as an S corporation.
Step 2: Ensure that the Filing Is TimelyIt is not enough to simply file Form 2553; it must also be timely filed. That is, it should be filed by the earlier of 75 days or two months and 15 days after the date the S election is to become effective. In other words, if an LLC is taxed on a calendar year basis, and the owners of that LLC want it to be taxed as an S corporation beginning in the subsequent calendar year, Form 2553 must be filed by about March 15 in that subsequent year. As another example, if the owners of the LLC do not wish to wait until the subsequent calendar year, then Form 2553 must be filed within the earlier of 75 days or two months and 15 days after the LLC was formed. In either case, when forming the business, the owners should immediately begin considering on how they wish to have the business taxed so that this important deadline is not missed. As long as Form 2553 is timely filed, the business will not have to file Form 8832. (Form 8832 is a separate election for corporate tax treatment.)
Other Items to Consider1) Owners of businesses taxed as S corporations must pay estimated taxes on a quarterly basis. 2) However, owners of businesses taxed as S corporations can avoid the excessive self-employment taxes that owners of LLCs not taxed as S corporations must pay. 3) Owner / employees of S corporations must be paid a "reasonable compensation" within their industry by regular monthly payroll. That compensation must be higher than the highest non-owner employee and greater than the amount of distributions paid. 4) The IRS has a targeted program under which it is auditing S corporations to determine whether they are paying reasonable compensation to their owner / employees. 5) If business owners elect to change the business's tax classification, the business cannot do so again during the 60 months after the effective date of the election without the IRS's permission. 6) If an S election is made, the LLC operating agreement may need to be amended to ensure that the business is complying with all of the IRS tests for S corporation status.