How to Convert a Single-Member LLC to an S Corp
Learn how a single-member LLC can elect S Corp tax status, a strategic decision that changes tax obligations and compliance without altering its legal structure.
A single-member limited liability company (SMLLC) is a business structure that legally separates the owner from the business. By default, the Internal Revenue Service (IRS) treats an SMLLC as a “disregarded entity,” meaning it does not file its own federal tax return. Instead, the owner reports all business income and expenses on their personal tax return, similar to a sole proprietorship. An S corporation is not a business entity but a tax election available to certain LLCs and corporations.
Electing to be taxed as an S corporation is purely a change in federal tax treatment and does not alter the SMLLC’s legal structure or liability protection.
Understanding the S Corp Election for an SMLLC
By default, all profits of an SMLLC pass to the owner and are reported on Schedule C of their personal Form 1040. These profits are subject to both income tax and self-employment taxes, which cover Social Security and Medicare at a combined rate of 15.3% on a portion of earnings. This means every dollar of profit is subject to this tax.
The S corp election changes how this income is handled. The owner must be treated as an employee and paid a reasonable salary, which is subject to FICA taxes. Any profit remaining after paying the owner’s salary and other expenses can be given to the owner as a profit distribution. These distributions are not subject to FICA or self-employment taxes.
This separation of income into salary and distributions is the primary mechanism for potential tax savings, as the owner pays income tax on both but self-employment tax only applies to the salary. For example, an SMLLC with $100,000 in net profit would normally have the full amount subject to self-employment tax. With an S corp election and a reasonable salary of $60,000, only that salary is subject to payroll taxes. The remaining $40,000 can be taken as a distribution, avoiding the self-employment tax on that portion.
Prerequisites for S Corp Election
An SMLLC must meet several IRS eligibility requirements to be taxed as an S corporation. The business must be a domestic entity, meaning it is formed and operates within the United States. It can have no more than 100 shareholders and must have only one class of stock. For an SMLLC, the single owner is the only shareholder, and they must be an eligible shareholder. This includes individuals who are U.S. citizens or residents, as well as certain trusts and estates; corporations, partnerships, and non-resident aliens are not permitted to be shareholders.
A primary prerequisite is determining the owner’s “reasonable compensation.” The IRS requires any shareholder providing services to the corporation to be paid a reasonable salary before any non-wage distributions are made. The IRS does not provide a specific formula for this amount, but it is defined as what similar businesses would pay for comparable services based on factors such as:
- The owner’s experience and duties
- Time devoted to the business
- Compensation paid to non-shareholder employees for similar work
Before filing, the business must have an Employer Identification Number (EIN). The owner must also decide on an effective date for the election and determine the business’s tax year, which is the calendar year for most small businesses.
Filing the S Corp Election
To change its tax status, an SMLLC must file Form 2553, Election by a Small Business Corporation, with the IRS. This form officially requests the change in tax status, and the owner, acting as a corporate officer, must sign it. The form requires the business’s name, address, EIN, and the chosen effective date. It also requires the owner’s name, address, Social Security number, and 100% ownership percentage.
To be effective for the current tax year, Form 2553 must be filed no later than two months and 15 days after the start of that tax year. For calendar-year businesses, the deadline is March 15. An election can also be made at any time during the preceding tax year. If a deadline is missed, the IRS offers late election relief if the business had a reasonable cause for the delay.
The completed form must be mailed or faxed to the IRS service center listed in the form’s instructions. Once the IRS accepts the election, it remains in effect until terminated or revoked and does not need to be filed annually.
Post-Election Responsibilities
After the S corp election is approved, the owner has new compliance obligations, starting with formal payroll. The owner’s reasonable salary must be paid through a payroll system, which withholds federal income tax and the employee’s share of FICA taxes. The business is also responsible for paying the employer’s share of FICA taxes and federal unemployment (FUTA) taxes, depositing these payments with the IRS on a schedule that is monthly or semi-weekly depending on the tax liability. The owner will receive a Form W-2 each year detailing their salary and withholdings.
Annual tax filing requirements also change. The business must file its own federal income tax return using Form 1120-S, U.S. Income Tax Return for an S Corporation, by March 15 for calendar-year businesses. This return reports the company’s income, deductions, and profits.
From the Form 1120-S, the business prepares a Schedule K-1 for the owner. The Schedule K-1 reports the owner’s 100% share of the corporation’s net profit or loss, which includes the distributions that are not subject to self-employment tax. The owner then uses the information from their Form W-2 and Schedule K-1 to file their personal Form 1040.