A single-member LLC can be taxed as an S Corporation if it meets the IRS’s eligibility criteria. In fact, both single-member and multi-member Limited Liability Companies can elect to be treated by the IRS as either an S Corporation or a C Corporation if they meet the requirements.
IRS’s S Corporation Qualification Criteria:
- Be a domestic corporation or an entity eligible to be treated as a domestic corporation. And not be an ineligible corporation (such as certain financial institutions, insurance companies, and domestic international sales corporations.
- Have only allowable shareholders such as individuals, certain trusts, and estates. No partnerships, corporations, or non-resident alien shareholders are allowed.
- Have no more than 100 shareholders.
- Have only one class of stock.
How a Single-Member LLC is Taxed as an S Corporation
Normally, a single-member LLC is taxed as a Sole Proprietorship, which means the owner and the business are considered the same tax-paying entity. The LLC’s profits and losses pass through to the owner’s personal income tax return. The LLC member gets paid through the owner’s draws from the business’s profits, typically a check from the company to the LLC member. Owner’s draws are not tax-deductible for the business. All of the LLC’s profits are subject to income tax and self-employment taxes (Social Security and Medicare).
When a single-member LLC is taxed as an S Corporation, profits and losses pass through to the owner’s personal income tax return. However, there’s a difference that may reduce the LLC owner’s personal tax liability. As an S Corporation, the LLC must put the owner on its payroll. The owner’s wages or salary are subject to income tax and FICA tax (Social Security and Medicare taxes). The remaining profit taken by the LLC member as distributions is subject to income tax but not Social Security and Medicare taxes.
How to Elect S Corporation Status for Single-Member LLCs
S Corporation election requires filing IRS Form 2253, Election by a Small Business Corporation. If an LLC wishes for the S Corporation election to be effective the following tax year, it can file Form 2553 anytime during the preceding year. If the LLC wants its S Corporation status effective in the current tax year, it must move more quickly.
- Form 2553 Filing Deadline for Existing LLCs – If an existing LLC wants its S Corporation election to be effective in the current tax year, it must file Form 2553 within two months and 15 days after the beginning of the LLC’s tax year.
- Form 2553 Filing Deadline for New LLCs – A new LLC must file Form 2553 to elect S Corporation status within two months and 15 days (75 days) after the entity’s date of formation.
The IRS may provide some relief for a late S Corporation election filing if the LLC has reasonable cause for failing to file the election and makes diligent efforts to correct the mistake after discovering it.
How to File Single-Member LLC Taxes
Under default taxation as a Sole Proprietorship, most single-member LLCs report their business profit or loss on Schedule C (Profit or Loss from Business) when filing their Form 1040 (U.S. Individual Income Tax Return).
For an S Corporation, tax preparation is a little more complicated. There’s some additional paperwork to file, including IRS Form 1120-S (U.S. Income Tax Return for an S Corporation).
S Corporation’s Compliance Requirements
While the S Corporation election affects how the LLC is taxed, the LLC’s other compliance responsibilities remain the same. In other words, the business is an S Corporation for tax purposes, but the underlying LLC legal entity remains in place and must follow the state’s LLC laws.
Generally, states require LLCs to maintain a registered agent, report and pay taxes, obtain any required business licenses and permits, file an annual report, and file articles of amendment when making certain changes to the business. Some may require LLCs to have an LLC operating agreement, an internal legal document that is helpful even if not required by law. There may be other requirements as well.
LLC compliance is typically less time-consuming and costly than corporate compliance. For example, bylaws, shareholders’ meetings, and a board of directors are requirements for corporations (for-profit and non-profit) but not for LLCs.
Should You Convert an LLC to an S Corporation?
An LLC owner might benefit from a less lofty Social Security and Medicare tax burden if electing S Corporation tax treatment for their single-member LLC. However, there are other factors to consider, such as the additional tax reporting requirements and possibly more scrutiny by the IRS. Some S Corps have been caught gaming the system to lessen their owner’s FICA obligations. An investigation might ensue and penalties applied if an LLC taxed as an S Corporation pays its owner an unreasonably low salary or wage and then pays the majority of profits as FICA-tax-free distributions.
As with any legal or tax matter, an S Corporation election is best discussed with a trusted, licensed professional who can provide informed insight specific to a business owner’s unique circumstances.
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