Your financial advisor or tax professional may have told you of the potential benefits if you decide to have your LLC file an election to be taxed as either a corporation or an S corporation. This article discusses the benefits and process of filing such an election and the correct form to use for making this election.
How an LLC Is Usually Taxed
- A single-member LLC pays income tax as a sole proprietorship, through the member's personal tax return.
- A multiple-member LLC pays income taxes as a partnership.
Both single-member and multiple-member LLCs may elect to be treated as a corporation or S corporation for income tax purposes.
Electing Corporation vs.S Corporation Status
The process of changing the tax status of an LLC to a corporation or S corporation is called an election. The two processes are different:
- To elect Corporation status, the LLC must file IRS Form 8832 - Entity Classification Election.
- To elect S Corporation status, the LLC must file IRS Form 2553 - Election by a Small Business Corporation.
An S corporation is a type of corporation, not a separate type of business. A business that is already a corporation files Form 2553 to elect to be an S corporation.
LLC Electing to be Taxed as a Corporation
Filing Form 8832
If you want your LLC to be taxed as a corporation, you must file Form 8832. Here are some things you need to know about this election:
- The form allows "eligible entities" to file this election, and LLCs are by eligible entities by definition.
- The form includes a consent statement which may be signed by all of the LLC members, or by one member on behalf of all members. If one member signs, there must be some record in company membership meetings that all members approved this election.
- You must provide the name(s) and identifying number(s) of owners (Social Security Number for a single-member LLC, and Employer ID for multiple member LLC).
The form directs you through a series of decisions and questions to a filing.
- The first section helps you to determine the eligibility of your business to apply for this change.
- The second section asks you to select your current entity type and the type you are selecting. (The terms "domestic" and "foreign" in this section have to do with the state where the business is registered.)
The last section includes a consent statement and requires signatures.
Single-Owner LLC's and Form 8832
If your LLC has only one member (a single-member LLC), the options noted on the form are to be classified as an association or be disregarded as a separate entity. An LLC with only one owner can be classified as a disregarded entity. This designation means the LLC is not separate from the owner for income tax purposes (filing business income taxes on Schedule C as part of the owner's personal tax return). There is nothing you need to do to have this classification.
If you check "No" in Box 3 because you don't have more than one owner, you will need to give the owner's name and identifying number "(taxpayer ID number). Then in Part I, Box 6, you would check Box C "A domestic eligible entity with a single owner electing to be disregarded as a separate entity" or Box F "A foreign eligible entity...."
LLC Electing to Be Taxed as an S Corporation
In the same way, as a corporation elects corporation tax status, an LLC may elect S corporation tax status by filing IRS Form 2553 with the IRS. The election must be made no more than two months and 15 days after the beginning of the tax year when the election is to go into effect. This article on how a corporation elects S corporation status will give you more details.
Why Elect S Corporation Status
The other tax option for your LLC is to elect to be taxed as an S corporation. Your LLC will need to meet the eligibility requirements of S corporation status. Both the LLC and S corporation are pass-through entities, meaning that the income of the business passes through to the owners.
S corporation status has two benefits:
S corporation officers who work in the business are considered employees. They are not considered self-employed and they don't pay self-employment taxes (Social Security/Medicare taxes) on their work income. This is a saving for these owners. But they must be paid a "reasonable salary" and pay income taxes on this income.
If you want your LLC to be taxed as an S corporation, you just need to file Form 2553. You don't need to elect to be taxed as a corporation first.
Form 2553 for Election to Be Taxed as an S Corp
Form 2553 is similar to Form 8832 above, with some differences.
- The election begins on a specific tax year and you must select the type of tax year, including fiscal year (financial year).
- Form 2553 discusses shareholders, but your LLC probably doesn't have shareholders. In this case, you should enter the percentage of ownership and date(s) acquired. A single-owner LLC would have 100% of the ownership.
- As with Form 8832, you must list all shareholders with their percentage of ownership, and taxpayer ID. All shareholders/owners must consent to the election.
Timing Your Tax Election
Before you decide to have your LLC elect corporation or S corporation status, make sure you are eligible to make this election. You must make the election at a specific time, relating to the tax year it will become effective. These details are also included in the Instructions.
Form 8832. You must designate an election effective date. The election can't take effect more than 75 days before the date the election is filed, nor can it take effect later than 12 months after the date of filing. (There is also a late election relief.)
For example, if you file the election on January 1, 2021, the election must take effect no earlier than October 18, 2020, and no later than December 31, 2021.
Form 2553. You must designate a tax year beginning with a specific month, day, and year. You must 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 example, if you designate January 1, 2021, as the beginning of your tax year, you must file the election in 2020, but no than March 15, 2021.
Disclaimer: Changing the tax status of a business is a complex issue and has potential tax and other effects you should be aware of. This article includes general information about the subject, but before you make any changes to the status of your LLC, discuss the benefits and drawbacks with your tax professional and tax attorney.