Making the Single Member LLC S Corp Election

By default, a single-member limited liability company (SMLLC) is a “disregarded entity” for federal tax purposes. This means the Internal Revenue Service (IRS) ignores the LLC as separate from its owner, and the business’s income and expenses are reported on the owner’s personal tax return, typically using Schedule C of Form 1040. An SMLLC owner can change this default tax treatment by making an S Corp election. This choice alters how the business is taxed by the IRS but does not change its legal structure as an LLC, and it is initiated by filing Form 2553.

Tax Implications of the S Corp Election

The primary motivation for an SMLLC to elect S Corp tax status relates to the treatment of employment taxes. In a default SMLLC, all net profit is subject to both regular income tax and self-employment taxes. The self-employment tax rate is 15.3%, which covers Social Security and Medicare, comprising 12.4% for Social Security up to an annual income limit and 2.9% for Medicare with no income cap.

When an LLC elects to be taxed as an S Corporation, the owner who works in the business is classified as an employee. This requires the business to pay the owner a “reasonable salary” for the services performed. This salary is subject to payroll taxes under the Federal Insurance Contributions Act (FICA), which are equivalent in rate to self-employment taxes. The tax is split, with the S Corp paying 7.65% as the employer and withholding 7.65% from the employee-owner’s paycheck.

Profits remaining after the salary is paid can be distributed to the owner, and these distributions are not subject to FICA or self-employment taxes. This creates an opportunity for tax savings. For example, with a net profit of $120,000, an S Corp election and a reasonable salary of $70,000 means only the salary is subject to FICA taxes. The remaining $50,000 can be taken as a distribution, avoiding those payroll taxes.

The IRS requires that the salary paid to an owner-employee must be “reasonable compensation” for the work performed. There is no exact formula, but the IRS considers factors like the owner’s experience, duties, and what comparable businesses pay for similar services. The agency scrutinizes S Corporations that pay artificially low salaries and can reclassify distributions as wages, resulting in back taxes and penalties. Documenting the research used to determine the salary is an important practice.

Eligibility and Key Decisions for the Election

Before an SMLLC can elect S Corp status, it must meet several IRS eligibility criteria. The business must:

• Be a domestic entity.
• Have no more than 100 shareholders.
• Ensure all shareholders are allowable, which includes individuals, certain trusts, and estates, but not partnerships, corporations, or non-resident aliens.
• Have only one class of stock, meaning all shares confer identical rights to distribution and liquidation proceeds.

The owner must also select the corporation’s tax year. For most single-member LLCs, the required tax year will be a calendar year ending on December 31. This aligns the business’s tax reporting period with the owner’s personal tax year, simplifying tax filing.

Information and Documentation for Filing Form 2553

To request S Corp tax status, the owner must complete and file Form 2553, Election by a Small Business Corporation. The owner will need the LLC’s full legal name, mailing address, and Employer Identification Number (EIN). If the LLC does not have an EIN, one must be obtained from the IRS before filing.

The form requires the LLC’s formation date and state, as well as the owner’s name, address, and Social Security Number. You must also specify the desired effective date for the S Corp election, which determines the start of the first tax year the business will be treated as an S Corporation.

Part I of Form 2553 captures the corporation’s details, the election’s effective date, and the selection of a tax year. It also includes the shareholder consent statement, which the single member must sign. For an SMLLC, this includes providing a signature, ownership percentage (100%), and the date ownership was acquired. Parts II and III of the form can usually be skipped as they relate to non-calendar fiscal years and specific trust elections.

The Filing Process and Deadlines

The filing deadline for Form 2553 is precise. To have the election take effect for the current tax year, the form must be filed no more than two months and 15 days after that tax year begins. For a calendar-year business, the deadline is March 15. A new LLC must file within two months and 15 days of its formation for the election to be effective immediately.

The IRS has procedures for late election relief, but these require the business to show reasonable cause for failing to file on time. It is best to adhere to the standard deadlines. The completed Form 2553 can be submitted by mail or fax, and the correct address or fax number is provided in the form’s instructions, based on the business’s location.

After submitting the form, the business must wait for confirmation from the IRS, which will send a formal notification letter if the election is accepted. This confirmation is the CP261 Notice. The IRS states it will notify the entity of its acceptance or non-acceptance within 60 days of filing. If no communication is received in this timeframe, contact the IRS to check the election’s status.

Ongoing Compliance as an S Corporation

Choosing to be taxed as an S Corporation introduces new compliance responsibilities, primarily the requirement to run formal payroll. The owner must be treated as an employee and receive their reasonable salary through a payroll system. This involves calculating and withholding federal and state income taxes, the employee’s share of FICA taxes, and remitting these amounts, along with the employer’s share of FICA and unemployment taxes, to tax agencies on a set schedule.

Annual tax filing procedures also change. The business is now required to file its own separate informational tax return, Form 1120-S, U.S. Income Tax Return for an S Corporation. This return reports the company’s income, deductions, and profits for the year. The deadline for filing Form 1120-S is March 15 for calendar-year businesses.

From the information on Form 1120-S, the S Corporation must prepare and provide a Schedule K-1 to the owner. The Schedule K-1 reports the owner’s share of the corporation’s income, deductions, and distributions. The owner then uses the information from the Schedule K-1 and their W-2 from the S Corp salary to complete their personal Form 1040 tax return. It is also important to investigate state-level requirements, as some states have separate S Corp election processes or impose entity-level taxes.