An S corporation imputes the taxable income of the corporation to the shareholders, who divide the business income amongst themselves and claim it on their personal tax returns. This entity makes sense for many small businesses, real estate agents, and investors; particularly when the business desires the corporate veil protections of an LLC combined with the tax benefits of an S corporation.
For business shareholders and owners to understand the benefits of forming an S corporation and evaluate if filing taxes as an S corporation makes sense, they first must be able to answer the question, what is an S corporation LLC?
Corporations are taxed, by default, as C corporations. The C corporation status requires the whole of the business’s taxable income be paid by the corporation. The shareholders then pay tax on any dividends, an effective double tax.
On the other hand, an S corporation LLC works well for many active income businesses, i.e. those who realize gains in fewer than 12 months. Active shareholders of an S corporation LLC can save significant amounts of money in self-employment taxes by paying themselves a reasonable salary, then classifying the remainder of their income as a shareholder distribution.
What is an S Corporation LLC?
An S corporation LLC is a limited-liability corporation that elects to file its taxes as an S corporation by using IRS Form 2553, otherwise known as the Election By Small Business form. Form 2553 must be filed prior to tax time. Once filed, the Internal Revenue Service will respond with an approval letter. All proper procedures for incorporation must be followed in order for S corporation tax status to be approved.
How to form an S Corporation LLC:
An LLC can be formed prior to making the decision to obtain S corporation status. The procedure to form an LLC is straightforward. First, become familiar with the regulations in the jurisdiction where you plan to conduct business. Then choose a business name that complies with these regulations.
Formal paperwork, commonly called the articles of incorporation, must be filed and a filing fee, usually several hundred dollars, must be paid. An LLC operating agreement, which spells out the LLC members’ rights and responsibilities, must also be created for the LLC to be valid. Some states require a notice of intent. All LLCs must obtain any required licenses and permits.
In order to qualify for S corporation status, Form 2553 must be filed by the 16th day of the third month of the corporation’s tax year, or the 15th day of the second month if the tax year is 2 1/2 months or less. Early birds can file Form 2553 at any point during the prior tax year.
What if you miss the Form 2553 deadline?
All is not lost if you follow the IRS’s special rules for making late S corporation elections. To qualify, the corporation must file Form 2553 as soon after the deadline as possible and write, “Filed Pursuant to Rev. Proc. 2013-30,” at the top. A detailed statement must be attached.
This statement must explain why the corporation failed to meet the deadline and demonstrate that it was for legitimate cause or because the deadline was inadvertently missed. Each shareholder must sign the statement.
S corporation status offers potential savings to LLCs. Shareholders should analyze their best potential tax status well before the Form 2253 deadline. It is always advisable to consult with a tax professional who can determine the best filing status and handle any requirements.