The default federal tax status for a single member limited liability company (SMLLC) is a disregarded entity. However, the owner of an SMLLC can elect to have the business taxed as either a traditional C corporation or as an S corporation.
An S corporation is a special type of small, closely-held corporation. An S corporation, same as with a typical LLC or sole proprietorship, is subject to pass-through taxation. This simply means that the responsibility for paying income tax passes through the business to the owner personally.
As the owner of a single-member LLC with S Corp status, you are not considered a self-employed person. Owing to that, you are not expected to pay federal self-employment tax.
However, since you are more or less considered an employee, you will have to take some or all of your company’s available profit as salary. Also, note that you can then take the remaining profit as a dividend to evade employment-related taxes and double taxation.
Requirements for Electing an S-Corp Status for LLC
Have it in mind that not every LLC qualifies for S-Corp taxation. In the United States, the IRS has established strict requirements for LLCs who intend to elect S-Corp status, and it’s most often limited to smaller, domestically owned companies. The requirements can be broken down into various segments, and they include;
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Entity and Structural Requirements
In the United States, note that only domestic LLCs are permitted to elect for S-corporation taxation status. This simply means that the business must have been formed or incorporated within the United States. Aside from that, the S-corporation must also not be an ineligible corporation.
The IRS notes ineligible corporations as “certain financial institutions, insurance companies, and domestic international sales corporations.”
If you own or manage any of these types of businesses, it is recommended you speak with tax professionals before making the move for an S-Corp election. Also note that your corporation will need to have one class of stock, neglecting differences in voting rights.
The IRS tends to consider the stock as being in one class if all shares maintain equal rights to distribution and liquidation proceeds. Since single-member LLCs do not issue stock, you should reach out to a lawyer or accountant to find out how this requirement applies to your business.
Also note that your S-corporation will be expected to meet certain strict requirements for the shareholders (or members, in the case of an LLC) who own your business. You are not expected to have more than 100 shareholders to qualify as an S-corporation.
You will also be expected to have what the IRS notes as “eligible shareholders,” and this entails that shareholders will have to be individuals, certain trusts, or estates. Shareholders will also need to be U.S. citizens or legal residents. Partnerships and corporations are not allowed to be shareholders.
Although profits from single LLCs elected to be taxed as an S-corporation aren’t subject to federal corporate income tax, your state may have different rules. A good number of states in the United States fully recognize S-corps, while others treat them as C-corps or warrant additional eligibility or filing requirements. You may have to file a separate state tax return for your S-corporation.
Have it in mind that you can elect S-Corp status by filing Form 2553 with the IRS coupled with filing any forms required by your state or jurisdiction. Just as was noted above, you are expected to have unanimous shareholder consent and meet the corporation and shareholder requirements outlined above to become an S-corporation.
After you must have filed Form 2553, you will have to file an annual tax return that shows your business’s election as an S-Corp. Unlike a traditional corporation, since an S-corporation is a pass-through entity, the information on your S-Corp tax return will be more enlightening.
Steps to Elect S Corp Status for Single Member LLC
In the United States, the LLC has the option of electing S Corp tax status, but it is expected to meet certain eligibility requirements as noted above. Nevertheless, if you are looking to elect S Corp status for your single-member LLC, here are steps to consider;
Form 2553 for Election to Be Taxed as an S Corp
To elect S corporation tax status, you will have to file IRS Form 2553, Election by a Small Business Corporation. Note that you can file an election for S corporation tax status at any time after setting up your SMLLC. However, don’t forget there are limitations on when the election can take effect.
The election starts on a specific tax year and you will have to select the type of tax year, including the fiscal year (financial year). Form 2553 discusses shareholders, and it simply means that you will be expected to list all shareholders with their percentage of ownership, and taxpayer ID.
Also, note that all shareholders/owners are expected to consent to the election. But since a single-member LLC doesn’t have shareholders, it is recommended you input the percentage of ownership and date(s) acquired (a single-owner LLC would have 100% of the ownership).
Time Your Tax Election
Right before you choose to have your LLC elect S corporation status; you must verify that you are eligible to make this election. You will also be expected to make the election at a specific time, and this will have to do with the tax year it will become effective. You will also have to designate a tax year beginning with a specific month, day, and year. You are expected to complete and file this form:
- No more than two months and 15 days after the beginning of the tax year the election is to take effect, or
- At any time during the tax year before the tax year, it is to take effect.
For instance, if you designate January 1, 2022, as the beginning of your tax year, you must file the election in 2021, but no more than March 15, 2022.