Benefits of LLC Electing S Corporation Tax Status

llc taxed as s corp

As entrepreneurs craft their business plans, one of the most important early decisions involves choosing the right business structure. The choice may seem difficult, but it carries meaningful implications for minimizing liability as the business grows and evolves.

With attentiveness and care, entrepreneurs can pick an entity that offers robust legal protections and tax advantages tailored to their visions and goals.

Legal Protections of a Limited Liability Company

Many entrepreneurs form limited liability companies (LLCs) because of how an LLC separates your business assets and activities from your personal finances.

By registering an LLC with the California Secretary of State, you establish your enterprise as a distinct legal entity that is separate from its owners. This helps to guard your personal assets, like your house, car, or savings, from being targeted if the LLC faces debts, lawsuits, or bankruptcy down the road. This means that, in most situations, plaintiffs can only go after the LLC’s assets—not yours.

Of course, exceptions apply if you personally guarantee a business loan or engage in fraud. But otherwise, the LLC structure shields you. It draws a dividing line between business and personal. For entrepreneurs, especially those with substantial personal assets or those entering riskier industries, LLCs bring invaluable peace of mind. You can devote yourself to growing the business without worrying that everything you’ve worked for personally may be at stake.

Tax Benefits of S Corporation Election

S corporation federal tax status turbocharges the tax advantages for your business. Checking a single box on IRS Form 2553 allows your LLC to gain these benefits without sacrificing any legal protections.

When first forming an LLC, the default tax classification treats the business as either:

  1. a sole proprietorship if single-member, or
  2. a partnership if multi-member.

This means LLC income gets taxed personally for you as the owner. While convenient initially, this classification has some downsides as your business matures. You pay self-employment tax on all LLC earnings, which may reach over 15%. And if your business becomes profitable enough, you could end up in a higher personal income tax bracket.

Making the S corporation election solves these issues by changing how your LLC gets taxed. As an S corp, your business becomes its own taxpaying entity, separate from individual owners.

This enables considerable tax savings in two main ways:

  1. Income, losses, deductions, and credits “pass-through” the business and get reported on owners’ personal returns. You avoid “double taxation,” where income gets taxed both for the LLC and for you personally. This pass-through framework applies taxes much more efficiently.
  2. Owners only pay FICA and self-employment taxes on “reasonable salaries”—not the full profits. This incentivizes leaving earnings in the business for investment and growth by lowering excessive payroll taxes. The IRS determines “reasonableness” based on your role and comparable compensation.

Combined, S corp status lets your LLC minimize taxes while maintaining limited liability protections. Many small businesses can pocket thousands extra per year. And unlike complex C corporations, S corps come with fewer record-keeping hassles and no double taxation.

You should consult a tax professional as part of your educated decision-making in this process. Nothing in this article should be construed as tax advice as TONG LAW is not a tax law firm and we do not specialize in tax law.

Tax Treatments for a Single-Member LLC

What if you launched your LLC as the sole owner without any partners? Does electing S corporation status still make sense? Absolutely. Not only can single-member LLCs take this step, but they often stand to benefit the most from changing the tax classification.

Remember, the default setting for an individually owned LLC is a sole proprietorship. This means you report all LLC income and expenses together with your personal taxes. And you pay self-employment tax on your business’s entire net income. For profitable LLCs, this tax obligation can really start to hurt.

Switching to S corp status for a single-member LLC brings three major improvements:

  1. Only FICA taxes apply to reasonable owner salary payments, not total income. This alone often yields substantial tax savings.
  2. Income distributions get taxed differently than salaries. You avoid payroll taxes completely on these dividends.
  3. Business losses can offset your other taxable income, generating additional personal deductions.

Consulting both a business attorney and a tax professional allows customizing your single-member LLC’s S corp election to minimize taxes while retaining liability protections. Carefully choosing your salary versus dividend distributions helps strike this optimal balance.

How to Elect S Corporation Status for Tax Purposes

Electing S corporation taxation unlocks considerable benefits, but how does this process actually work? The mechanics boil down to filing IRS Form 2553 to change your LLC’s tax classification to an S corporation.

Some key steps for completing this include:

  • Unanimous member consent
  • Member signatures agreeing to the election
  • Members to hold U.S. citizenship or alien residency
  • Only a single class of ownership interest
  • No more than 100 shareholders

Meeting these requirements allows the LLC to gain pass-through S corp taxation without disrupting business operations or liability protections. From the outside, customers will still interact with your LLC brand and name. But internally, your business gets treated as an S corporation come tax season.

The initial IRS Form 2553 sets everything in motion to start reaping tax rewards. With a few signatures and supporting details, your LLC can morph into a hybrid S-corp entity. For more information or help electing S Corp status, we recommend consulting a tax professional and your business law attorney.

Combined Benefits for Business Owners

Stepping back, we’ve explored how limited liability companies shield your personal assets (protecting your home, savings, and belongings). We’ve also seen how electing S corp status can unlock tax benefits compared to default LLC tax classifications. Filing a simple IRS form marries these two advantages together into one efficient, protective structure.

Entrepreneurs enjoy the best of both worlds in this hybrid LLC/S corp model. Limited liability gives peace of mind for risky endeavors. S corporation taxation minimizes self-employment taxes while incentivizing business growth. Owners gain personal asset protection, business investment tax breaks, and operational flexibility to issue shares and add partners down the road.

The LLC/S corp combination also beats alternative options like C corporations or sole proprietorships for many small businesses. Requirements for S corporation status have fewer restrictions on shareholders compared to C corporation. Taxes get handled more efficiently than sole proprietorships. And unlike partnerships, no general partner shoulders unlimited liability.

For these reasons and more, LLCs checking the S corporation box have become incredibly popular for entrepreneurs. Over two-thirds of new companies follow this route for the unbeatable blend of liability and tax optimization. It empowers business dreams with reduced risks and sustained rewards.

Contact TONG Law Today

Forming a limited liability company while electing S corporation tax status strategically combines robust legal protections with considerable tax savings.

This hybrid structure fuels entrepreneurship by safeguarding personal assets as businesses take risks and chase opportunities. TONG LAW guides clients in launching and growing their S-corp LLCs.

Reach out to TONG LAW today with any questions while building your enterprise. Our attorneys stay current on all laws and forms to guide your entity creation and election filings. Don’t leave money or protections on the table. Contact us to form or manage your cutting-edge hybrid LLC/S Corp.

Author Bio

Vincent Tong

Vincent Tong is the CEO and Managing Partner of TONG LAW, a business and employment law firm located in Oakland, CA. Vincent is a fierce advocate for employees facing discrimination and wrongful termination. With several successful jury trial victories and favorable settlements, he has earned a strong reputation for delivering exceptional results for his clients.

In addition, Vincent provides invaluable counsel to businesses, guiding them on critical matters such as formation and governance, regulatory compliance, and protection of intellectual property assets. His depth of experience allows him to anticipate risks, devise strategies to avoid legal pitfalls, and empower clients to pursue their goals confidently.

Vincent currently serves as the 2021 President of the Board of Directors for the Alameda County Bar Association and sits on the Executive Board for the California Employment Lawyers Association. Recognized for outstanding skills and client dedication, he has consecutively earned the Super Lawyers’ Rising Star honor since 2015, reserved for the top 2.5% of attorneys. He also received the Distinguished Service Award for New Attorney from the Alameda County Bar Association in 2016. He is licensed to practice before all California state courts and the United States District Court for the Northern and Central Districts of California.

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