When Should an LLC Elect S-Corp Status?

An LLC can choose to be taxed as an S corporation. For some owners it lowers self-employment taxes. For others it adds cost and paperwork with little benefit. Here is how to decide.

What the election does

An LLC that qualifies and elects S corporation status files Form 1120-S, and owners report their shares of income on a Schedule K-1. In general, owners who work in the business are paid wages through payroll, and remaining profit can be passed through as distributions. That payroll step is where the extra work comes in.

Who is eligible

The IRS instructions for Form 2553 list the main tests:

No more than 100 shareholders. A spouse and certain family members can count as one.
Only eligible shareholders: individuals, estates, certain exempt organizations, and certain trusts. Nonresident aliens are not eligible, with a narrow exception for certain trust beneficiaries.
One class of stock. Generally, all shares must have identical distribution and liquidation rights. Differences in voting are allowed.
A qualifying entity. Banks using the reserve method for bad debts, insurance companies taxed under subchapter L, and DISCs can’t elect.
An acceptable tax year, and every shareholder must consent.

If an owner of your LLC lives abroad as a nonresident alien, an S election is generally off the table. See Virginia LLCs with foreign owners.

The deadline

Form 2553 is due no more than 2 months and 15 days after the start of the tax year the election takes effect. You can also file it at any time during the preceding tax year. For a new entity with no prior tax year, an election made before its first tax year begins isn’t valid.

Late election relief

If you miss the deadline, relief may be available when you had reasonable cause and acted diligently once you found the problem. The form must be filed within 3 years and 75 days of the intended effective date, with “FILED PURSUANT TO REV. PROC. 2013-30” written at the top. Otherwise, you generally must request a private letter ruling and pay a user fee.

When it might make sense

You have steady profit that is well above what you would pay yourself as a salary.
You’re comfortable running payroll and filing extra returns.
All owners are eligible shareholders.

When it might not

Profit is low or uneven. The payroll cost can wipe out the savings.
You’d rather keep things simple.
Your state taxes S corporations differently. Check your state’s rules.

Questions to answer first

What is the LLC’s expected net profit?
What would a reasonable salary for your work be?
Who are the owners now, and who might they be later?
Are you ready for payroll, deposits, and quarterly filings? See payroll tax deposits.

Weighing an S election? Book a call with FlowTex and we’ll work through the numbers with you.

Sources

This article is general information, not tax or legal advice. The right choice depends on your facts. Talk to a qualified professional before electing.