An LLC can elect to be taxed as an S corporation for federal tax purposes. The LLC remains an LLC under state law, but the IRS applies S corporation tax rules after the LLC files Form 2553 and meets the eligibility requirements. For a calendar-year LLC, the usual filing deadline is March 15 for an election that applies to that tax year, subject to weekend and holiday adjustments.

An S corporation is a tax election, not a separate business entity. In most cases, the LLC does not need to convert into a corporation to make the election.

LLC Taxed as an S Corporation: At a Glance

Question Answer
Can a single-member LLC elect S corporation taxation? Yes.
Can a multi-member LLC elect S corporation taxation? Yes, if it meets the eligibility rules.
Does the LLC stop being an LLC? No. It remains an LLC under state law.
What form is required? IRS Form 2553, Election by a Small Business Corporation.
Is Form 8832 also required? Usually no. A qualifying LLC can generally file Form 2553 directly.
What tax return does the LLC file? Form 1120-S.
Must an owner who works in the business receive a salary? Generally yes. The salary must be reasonable for the services performed.
Is S corporation taxation automatically cheaper? No. Any tax savings must outweigh payroll, accounting and compliance costs.

How Does an LLC Elect S Corporation Status?

An eligible LLC generally elects S corporation taxation by filing Form 2553 with the IRS.

The usual steps are:

  1. Confirm that the LLC meets the S corporation eligibility rules.
  2. File Form 2553 with the IRS.
  3. Set up payroll for owner-employees who perform services.
  4. Pay reasonable compensation before taking non-wage distributions.
  5. File Form 1120-S and provide each owner with a Schedule K-1.

When an eligible LLC files Form 2553, the IRS generally treats the LLC as having elected corporate tax classification as part of the S corporation election. The LLC usually does not need to file Form 8832 first.

What Are the Requirements for an LLC to Qualify as an S Corporation?

An LLC must meet the federal S corporation eligibility rules before making the election. The main requirements are:

  • The business must be organized in the United States.
  • It generally cannot have more than 100 shareholders.
  • Owners must be eligible shareholders, such as individuals, certain trusts and estates.
  • The business cannot have a partnership, corporation or nonresident alien as a shareholder.
  • It may have only one class of stock.
  • All required owners must consent to the election.
  • It cannot be an ineligible corporation, such as certain financial institutions, insurance companies or domestic international sales corporations.

The LLC's operating agreement should also be reviewed. Special allocation rights, preferred economic rights or other provisions that give owners different economic rights can create S corporation compliance problems.

What Is the Deadline to Elect S Corporation Taxation?

For a calendar-year business, Form 2553 is generally due no later than two months and 15 days after the beginning of the tax year for which the election is intended to apply.

For a business whose tax year begins on January 1, that usually means March 15. The deadline can move when March 15 falls on a weekend or holiday.

An LLC can also file Form 2553 during the preceding tax year to make the election effective for the following year. The IRS has procedures for requesting relief from certain late elections, but late-election relief is not automatic.

How Does S Corporation Taxation Change the Way an LLC Owner Gets Paid?

An owner of an LLC taxed as an S corporation generally receives two types of payments:

  1. Wages: Compensation for services performed for the business, reported on Form W-2.
  2. Distributions: Payments made to the owner as a shareholder after the business accounts for reasonable compensation.

A shareholder-employee who performs services for the S corporation must generally receive reasonable compensation before taking non-wage distributions. The IRS can reclassify distributions as wages when an owner performs substantial services but reports little or no salary. That can create additional payroll taxes, penalties and interest.

The IRS does not set one salary percentage that applies to every business. Reasonable compensation depends on factors such as:

  • The owner's duties and responsibilities
  • Training and experience
  • Time devoted to the business
  • Pay at comparable businesses
  • The company's revenue sources
  • Compensation paid to other employees
  • The owner's compensation history

Why Do LLC Owners Elect S Corporation Taxation?

The main potential benefit is that an S corporation's pass-through income generally is not treated as self-employment income. Wages paid to the owner remain subject to payroll taxes, but qualifying business income distributed through the S corporation generally is not subject to self-employment tax.

For example, an owner-operated LLC might:

  • Pay the owner a reasonable salary for services.
  • Pay payroll taxes on that salary.
  • Pass the remaining business income through on Schedule K-1.
  • Make shareholder distributions when appropriate.

This arrangement can reduce employment-tax exposure for some profitable businesses. It does not eliminate federal income tax on the business income. S corporation shareholders generally must report their share of the corporation's income whether or not the business distributes the cash.

When Is S Corporation Taxation Worth Considering?

S corporation taxation is generally worth evaluating when an LLC has:

  • Consistent profit after paying the owner a reasonable salary
  • An owner who actively works in the business
  • Enough profit to justify payroll and tax-return preparation
  • A straightforward ownership structure
  • Owners who meet the S corporation eligibility rules

The election may not be worthwhile when the business has:

  • Little or inconsistent profit
  • Substantial startup losses
  • Payroll and accounting costs that take up much of the potential savings
  • Owners who need flexible profit-sharing arrangements
  • Ineligible owners or ownership interests
  • Income that is already almost entirely compensation for the owner's services

There is no universal profit level at which S corporation taxation becomes beneficial. The result depends on the owner's reasonable salary, payroll taxes, federal and state taxes, benefits, accounting costs and administrative work.

What Are the Main Disadvantages?

Additional Payroll Obligations

An owner who works for the S corporation may need to be placed on payroll. This can require payroll filings, tax deposits, Forms W-2 and additional bookkeeping.

More Complex Tax Filing

An S corporation files Form 1120-S and issues a Schedule K-1 to each owner. Owners report their allocated income, deductions and credits on their individual tax returns.

Reasonable Compensation Risk

Paying an artificially low salary while taking large distributions can lead the IRS to reclassify some or all of those distributions as wages. The result may include additional payroll taxes, penalties and interest.

Distribution and Basis Rules

S corporation distributions are not automatically tax-free. A non-dividend distribution is generally tax-free only up to the shareholder's stock basis. Some distributions may be taxable depending on the corporation's earnings, profits and basis calculations.

Ownership Restrictions

S corporations do not offer the same ownership flexibility as many LLCs. The 100-shareholder limit, eligible-owner rules and one-class-of-stock requirement can make an S corporation less suitable for outside investors or complex ownership arrangements.

LLC Versus LLC Taxed as an S Corporation

Feature LLC with Default Tax Treatment LLC Taxed as an S Corporation
Legal entity LLC LLC
Federal tax treatment Disregarded entity for a single-member LLC or partnership for a multi-member LLC, unless another election is made S corporation
Owner compensation Depends on the default tax classification Working owners generally receive W-2 wages
Business tax return Schedule C, Form 1065 or another applicable return Form 1120-S
Owner tax form Schedule C or Schedule K-1, depending on classification Schedule K-1
Payroll administration Usually simpler for the owner More involved
Self-employment tax Often applies to active LLC business income under default treatment Generally applies to wages, but not to qualifying S corporation pass-through income
Ownership flexibility Usually greater More restricted

The default federal tax treatment depends on whether the LLC has one owner or multiple owners and whether it makes a tax election.

Bottom Line

An LLC can elect S corporation taxation without changing its legal status as an LLC. The usual federal filing is Form 2553.

Before filing, compare the expected payroll-tax savings with the cost of payroll, accounting, Form 1120-S preparation and ongoing recordkeeping. A tax professional should also review the LLC's ownership structure, compensation plan and state tax treatment.