Limited liability companies (LLCs) provide unmatched versatility and liability protection, and the Internal Revenue Service (IRS) allows LLC owners to pay their taxes as a different business structure. For many LLCs, filing taxes as an S corp. is the best option.
You can switch to S corp. tax status in a few simple steps. We'll break down all your LLC tax options and explain how to file your LLC taxes as an S corp.
LLC tax options
You can change how to files taxes at any point after forming your LLC. An LLC can file taxes as a sole proprietorship, a partnership, a C corporation, or an S corporation. We'll break down each IRS tax classification by category:
- S corporation. S corporations pay taxes like partnerships and sole proprietorships do. A multimember or single-member LLC taxed as an S corp. doesn't pay taxes on its corporate profits. Instead, members file personal income taxes on corporate profits.
- C corporation. Single-member and multimember LLCs follow the same process for C corp. filing. An LLC taxed as a C corp. pays taxes on its profits twice. First, the IRS taxes corporate profits. Then any profits passed on to the members face personal income tax.
- Partnership. LLCs taxed as partnerships require two or more members. The LLC itself is not taxed, but profits the LLC contributes to the members incur personal income tax.
- Disregarded entity separate from its owner. This refers to a single-member LLC and is the same as a sole proprietorship. LLC income and expenses equate to the business owner's income and expenses. As such, profits show up on a personal tax return.
Regardless of how the LLC files taxes, each member will be responsible for paying quarterly estimated taxes and any required self-employment tax.
Default LLC tax classifications
Because LLCs don't have their own tax status, the IRS will assign a default classification to each business. If you do not file any special forms with the IRS to change your tax classification, your LLC will file taxes as either:
- A sole proprietorship (if you are the only member)
- A partnership (if your LLC has two or more members)
What is the best taxation type for an LLC?
The best tax classification for your LLC depends on your business size, long-term goals, and industry, as all tax statuses have unique advantages and limitations. Learning the best way to file taxes for your LLC can dramatically improve its finances.
Sole proprietorships and partnerships often work well for small businesses. These structures keep control in fewer hands and simplify tax filing. On the other hand, finding investors becomes much more difficult. For many LLCs, S corporations provide a happy medium between retaining control and finding investors.
Larger businesses trend toward filing as corporations. While corporations introduce more requirements to stay compliant, they grow more quickly. C corporations can issue multiple classes of stock and accept investments from other businesses. S corporations restrict who can invest in your company but offer pass-through taxation.
Should your LLC elect S corp. status?
LLC owners have to consider multiple factors when picking a tax status. Members need to consider:
- How much profit they're anticipating.
- Whether they will distribute income to owners or let the business retain it.
- If they have or intend to hire employees.
- The benefits offered to employees and members.
- How the state will tax each entity.
Benefits of filing LLC taxes as an S corp.
While all tax statuses offer advantages, LLCs that file as an S corp. get some of the best benefits. The LLC-to- corp. pipeline offers key benefits:
- Retain LLC structural advantages: Even though you will pay taxes as an S corp., you won't have to restructure as a corporation. You can continue to enjoy the ease of administration—fewer formal meetings and record-keeping requirements.
- Pay wages and salaries to LLC members: On top of their dividends, owners can receive wages from their S corporations. However, the IRS subjects this income to FICA tax and other withholding requirements.
- Earn dividends from the company's net earnings: After paying salaries, the remaining profits pass through to members as dividends. Unlike wages, dividends aren't subject to Self-Employed Contributions Act (SECA) taxes.
- Use more opportunities for tax planning: S corporations get access to deductions and strategies that minimize your overall tax liability.
- Avoid double taxation with pass-through taxation: C corporations pay income taxes twice: once for corporate profits and once for personal income. S corporations let corporate profits pass through to owners, who are only taxed once.
- Enjoy pass-through tax deductions: Companies with pass-through taxation can deduct up to 20% of their net business income from their income taxes. Any business owner can take this personal deduction whether or not they itemize deductions.
Considerations for filing as an S corp.
Members need to know that an LLC electing S corp. status comes with a few considerations:
- Pass-through deduction qualification: You will only qualify for the 20% pass-through deduction if your income falls within IRS thresholds. In 2023, the limits went up to $182,100 for individuals and $364,200 for joint filing.
- Shareholder limitations: If you file as an S corp., you can only have up to 100 shareholders. Additionally, no shareholder can be a noncitizen or business entity.
- Restrictions on stock: Your LLC can only issue one class of stock.
- Limitations on investors: S corp. shareholders have to be individuals. Other firms or companies cannot purchase stock.
- Greater IRS scrutiny: The IRS doubles down on reviewing S corporations' tax returns. Double-check every tax filing to avoid penalties and fines over errors.
How is income from an LLC taxed?
Income from an LLC is taxed based on its assigned or chosen tax classification. Once you've settled on your tax status, you still need to file with the IRS. We'll outline possible tax scenarios and the proper forms to file for each:
LLC filing as an S corp.
The LLC will file Form 1120S. Each member needs to report their share of the profits on their individual Form 1040, along with Schedule K-1 (Form 1120S).
LLC filing as a C corp.
The LLC will file Form 1120. This form covers the corporate tax rate on company profits. If any shares of the profits pass on to the owners, each member will report their share on Form 1040. They must also file with Schedule B, Interest and Ordinary Dividends.
LLC filing as a partnership
The LLC will file IRS Form 1065, U.S. Return of Partnership Income, showing each member's share of the profit or loss. Each member will report their share of the profits or losses on their individual Form 1040, along with Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc.
LLC filing as a sole proprietorship
You will report the income and expenses of the business on your individual Form 1040, along with Schedule C, Profit or Loss From Business (Sole Proprietorship), Schedule E, Supplemental Income and Loss, or Schedule F, Profit or Loss From Farming.
Note: Sole proprietors and partnerships have more flexibility in filing with their tax ID. Corporations must file with an employer identification number (EIN). Partnerships and proprietors can file with an EIN or Social Security Number (SSN)
How to elect S corp. status
If you want your LLC to be taxed as an S corp., you need to file IRS Form 2553, Election by a Small Business Corporation.
If you file Form 2553, you do not need to file Form 8832, Entity Classification Election, as you would for a C corp. You may use online tax filing or file by fax or mail.
Note: For business owners asking if an LLC can be an S corp., the answer is yes. While filing as an S corp. offers tax advantages, some owners want the structure of an S corp. as well. To decide if that's the best strategy, consult a tax attorney and your registered agent.
When should LLCs start filing as an S corp.?
From a tax savings perspective, LLCs should convert to S corporations when their self-employment tax exceeds the tax burden of filing as an S corp. Most LLCs will hit this point when their net income reaches $40,000. But in some cases, this can occur as low as $25,000.
Other factors to consider include:
- Salaries: S corp. owners can take a salary from their net profits. Depending on your industry, this could net you more income overall.
- Foreign Earned Income Exclusion (FEIE): Owners who qualify for FEIE can exclude up to $120,000 of their salary from income taxes.
- State of operation: Certain states like California and New York tax at the S corp. and individual level. LLCs that file as S corporations in these states will see diminished tax savings. Consult your registered agent to learn more about your state's taxes.
Leveraging LLCs with S corp. status
LLCs enjoy advantages no other business can structure can reach. They let owners combine tax savings with a streamlined business structure. By running an LLC taxed as an S corp., you'll balance careful management with unbeatable tax benefits.
When electing S corp. status for LLCs at the right time, you'll enable long-term growth and savings for the members who helped get your business off the ground. By weighing the pros and cons of this choice and filing the proper paperwork, you can set your LLC up for long-term success.
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