Electing Subchapter S (S-Corp) Taxation as a LLC

A limited liability company has the option to elect to be taxed under Subchapter S of the Internal Revenue Code (also known as S-Corp taxation), assuming it meets the requirements, which include having only one class of equity, no more than 100 shareholders, and having all shareholders be U.S. citizens/U.S. nationals/permanent residents of the U.S., among other requirements. Subchapter S taxation is what is known as “pass-through” taxation, in that the profits and losses of the LLC are “passed through” to its owners, who are responsible for paying their respective shares of the tax. Owners of a LLC taxed under Subchapter S can also avoid self-employment taxes. In order to elect Subchapter S taxation, the LLC must file Form 2553 within 2 months and 15 days (75 days) of the beginning of the tax year in which it wants to be taxed under Subchapter S (so if your LLC’s tax year is the calendar year, by March 15 of the year you want to elect) — if the LLC is formed in the midst of its chosen tax year and wants to be taxed under Subchapter S in that tax year, it must file Form 2553 within 2 months and 15 days (75 days) of formation. The IRS does accept late elections, but that comes with additional paperwork and delay, so it is best to ensure your election is timely. However, LLCs considering Subchapter S taxation must consider a few things. First, make sure that the structure of the LLC and its operating documents allow the LLC to qualify for Subchapter S taxation. Furthermore, once the Subchapter S election is made, an election to another form of taxation cannot be made within 60 months without the permission of the IRS (which is not necessarily easy to come by). Under Subchapter S, LLCs must also pay estimated quarterly taxes. Owners can avoid self-employment tax under Subchapter S, but they must be paid a “reasonable compensation” by regularly monthly payroll, which must be higher than the highest non-owner employee’s pay, and greater than the amount of distributions paid. The IRS does audit companies taxed under Subchapter S to ensure that they are in compliance with this rule. If you are considering Subchapter S taxation for your LLC, it is critical to consult with your LLC’s tax advisor to determine if the LLC qualifies and if the benefits of Subchapter S outweigh its requirements in your LLC’s particular situation.

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