Can Your LLC Elect S Corporation Tax Status

Yes, an LLC can elect to be taxed similar to an S corporation. You may question, why you would even want this type of tax treament? Read on and I'll explain.

Owners or members of an LLC have the option to choose the form of tax treatment they will receive. However, this was not always the case. In the past, the Internal Revenue Service (IRS) classified business entities as either partnerships or corporations based on four different factors.

The four factors included: (1) Limited liability; (2) Centralized management; (3) Continuity of life; and (4) Free transferability of interest. If a business entity possessed two of the four characteristics, the entity would be taxed as a partnership. But if three of the four characteristics applied, the entity would be taxed under the double taxation regime of corporations. This "four factor" approach led to a lot of confusion and uncertainty for business owners.

Then in 1997, new IRS regulations came into effect which allowed business entities like LLCs to elect the tax treatment they desired. These regulations became known as the "check-the-box" regulations. They can be found in Income Tax Regulations 301.7701-1 through 301.7701-3. The form for making the election is IRS Form 8832 and details about the election process are set forth in the instructions to Form 8832.

The regulations give business entities like the LLC several different options. They can operate as an LLC but still enjoy the beneficial characteristics of a corporation while being taxed similar to a partnership. In the alternative, the regulations allow an LLC to elect corporation tax status and then make the S corporation election.

In summary, partnership taxation provides for the income and deductions to flow through or "pass through" to the partners who then report and pay income tax on their individual tax returns. Partnership taxation is the basic method of taxation for most LLCs and S corporations. On the other hand, if an entity is classified as a corporation, then income taxes will generally have to be paid by the corporation on income that it earns and then later when that income is paid to the shareholders in the form of dividends, they will have to pay tax at their personal level. This results in double taxation and needs to be avoided where possible.

Most small businesses can avoid this double taxation either by forming an LLC or electing S corporation status. LLCs by default receive partnership taxation. This means if the owners do not make an election by filing Form 8832 to be taxed as something different than a partnership the LLC and its members will automatically be subject to partnership taxation principles. A corporation which makes the S election is also subject to the basic partnership taxation principles with a few exceptions. Both LLCs and S corporations are considered pass through entities for tax purposes and are subject, with a few exceptions, to the partnership form of taxation.

According to the accountants and tax advisors I work, a business owner can reduce (not eliminate) the FICA or 15.3% self employment tax by forming a corporation and making the S election. However, this reduction in FICA taxes is not available in most cases to the members of an LLC. So a business person can form an LLC and then make the election to be taxed as a corporation by filing IRS Form 8832 and then make the S election by filing IRS Form 2553. By doing this, the LLC can operate with the less formal structure and rules associated with corporations but also obtain reduced FICA tax treatment for the members.

Setting up an LLC which elects tax treatment similar to the S corporation, may be an attractive option to discuss with your accountant or tax advisor. In addition to being able to operate under the less formal requirements of an LLC, you get limited liability protection, basic partnership taxation, with a few exceptions, and the chance to reduce FICA taxes for the members of the LLC.

Attorney Robert Montgomery provides valuable resources for your LLC s corpration election form LLC (LLC)
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