Should My LLC Be an S Corp for Tax Purposes?

An LLC is a legal entity formed under state law that provides liability protection, while an S Corporation is a tax classification granted by the Internal Revenue Service (IRS) that changes how a business is taxed at the federal level. An LLC can choose to be taxed as an S Corp if it meets certain criteria. This decision involves weighing the default tax rules for an LLC against the potential advantages and additional responsibilities of the S Corp election. Understanding the core differences in how profits are taxed, particularly concerning self-employment taxes, is a large part of this analysis.

Understanding Default LLC Taxation

By default, the IRS taxes an LLC based on its number of members. A single-member LLC is automatically treated as a “disregarded entity,” which for tax purposes means it is taxed like a sole proprietorship. The owner reports all business income and expenses on Schedule C, “Profit or Loss from Business,” which is filed with their personal Form 1040 tax return. This structure blends the business’s financial results directly with the owner’s personal tax situation.

For an LLC with two or more members, the default tax classification is a partnership. In this scenario, the LLC must file an annual information return, Form 1065, “U.S. Return of Partnership Income.” This form reports the business’s total income, deductions, gains, and losses. The LLC does not pay taxes directly; instead, it issues a Schedule K-1 to each member, detailing their respective share of the profits or losses, which they then report on their personal tax returns.

Under both default scenarios, the LLC’s profits are subject to pass-through taxation, meaning the income “passes through” the business to the owners’ personal returns. All net profits are considered self-employment income, which is subject to self-employment taxes for Social Security and Medicare. The tax is calculated on 92.35% of the net earnings. For the 2025 tax year, the rate is 15.3% on the first $176,100 of earnings and 2.9% on earnings above that threshold.

How S Corporation Taxation Works

Electing to have your LLC taxed as an S Corporation changes how its profits are treated for tax purposes. The structure allows for splitting the company’s income into two categories: a reasonable salary for the owner-employee and distributions of remaining profits. This separation is the primary mechanism through which tax advantages are realized, specifically by reducing the amount of income subject to self-employment taxes.

When an LLC is taxed as an S Corp, the owner who works in the business must be paid a “reasonable salary.” This salary is subject to FICA taxes, which are the employee-equivalent of self-employment taxes, covering Social Security and Medicare. The FICA tax rate is 15.3%, but it is split between the employee and the employer, with each paying 7.65%. The business can deduct its 7.65% share as a business expense.

Any remaining net profit after the salary and other business expenses are paid can be passed through to the owner as a distribution. These distributions are not subject to FICA or self-employment taxes. The portion of income received as a distribution is only subject to federal and, if applicable, state income tax. Higher-income individuals may be subject to an Additional Medicare Tax of 0.9% on earnings that exceed certain thresholds, such as $200,000 for single filers or $250,000 for those married filing jointly.

To illustrate, consider an LLC with $100,000 in net profit. If the owner elects S Corp status and determines a reasonable salary is $60,000, only that amount is subject to FICA taxes. The remaining $40,000 can be taken as a distribution, which is not subject to the 15.3% FICA tax. This results in a tax savings of $6,120 (15.3% of $40,000) compared to the default LLC taxation. The concept of “reasonable salary” is based on what comparable positions pay in the same industry and geographic location for similar work.

Key Requirements for the S Corp Election

An LLC must meet a specific set of eligibility criteria from the IRS to elect S Corp status. Failure to comply can result in the termination of the S Corp status. The requirements are:

• The entity must be a domestic business and cannot be an ineligible type of corporation, a category that includes certain financial institutions and insurance companies.
• It can have no more than 100 shareholders. For this count, members of a family may be treated as a single shareholder.
• All shareholders must be “allowable,” which includes individuals, certain trusts, and estates. Partnerships, corporations, and non-resident alien individuals are prohibited from being shareholders.
• The company must have only one class of stock, meaning all shareholders must have the same rights to the company’s profits and assets upon liquidation. Distributions must be proportional to the ownership percentage of each shareholder.

The Process of Making the Election

Once you have determined your LLC is eligible, the next step is to formally make the election with the IRS by filing Form 2553, “Election by a Small Business Corporation.”

Completing Form 2553 requires providing the LLC’s legal name, mailing address, and Employer Identification Number (EIN). The form also asks for the date the business was formed and the state of formation. All shareholders must consent to the election by signing the form, and you will need to list their names, addresses, and ownership percentages.

Filing deadlines for Form 2553 are precise. For the election to take effect in the current tax year, the form must be filed no more than two months and 15 days after the beginning of that tax year. For a business that uses the calendar year, this deadline is March 15. For a newly formed business, the deadline is two months and 15 days from its date of formation. The completed form is submitted to the IRS either by mail or fax.

Ongoing Compliance for an LLC Taxed as an S Corp

After the IRS approves the S Corp election, the LLC must adhere to new administrative and tax compliance responsibilities. A primary change is the requirement to run formal payroll for any owner who provides services to the company.

The owner-employee’s reasonable salary must be processed through a payroll system. The business is responsible for withholding federal income taxes, as well as the employee’s share of FICA taxes (7.65%), from each paycheck. The LLC must also pay the employer’s share of FICA taxes and make regular payroll tax deposits to the IRS, typically on a quarterly basis using Form 941.

Determining and documenting the reasonable compensation figure is another compliance task. The salary must be defensible to the IRS, which scrutinizes salaries that appear artificially low to maximize tax-free distributions. Business owners should research industry data, document the owner’s specific job duties and hours worked, and keep a record of how the salary was determined. This documentation is important in the event of an IRS audit.

Finally, the annual tax filing process changes. The LLC must now file a corporate tax return, Form 1120-S, by March 15 of each year for a calendar-year business. The LLC will also issue a Schedule K-1 to each shareholder, which details their share of the salary, distributions, and other income or loss items to be reported on their personal Form 1040.