LLC vs S corp: it's not either-or

An LLC is a structure; an S corp is a tax choice

You form an LLC with your state. It separates the business's debts and liabilities from you, and that protection is the same however the LLC is taxed. For taxes, an LLC has a default: with one owner it's treated like a sole proprietorship, and with two or more like a partnership. An LLC can instead elect to be taxed as an S corporation. It stays an LLC legally — same name, same state filings, same protection. Only the tax treatment changes.

How an LLC is taxed, and how an S corp is

Why an LLC elects S corp status

One reason, mostly: self-employment tax. As a default LLC, you pay 15.3% self-employment tax on nearly all the profit (up to the Social Security wage base, then 2.9%). Taxed as an S corporation, you pay payroll tax on a reasonable salary and take the rest as distributions, which carry none. On $150,000 of profit with a $70,000 salary, that's roughly $10,000 of payroll tax avoided — before the costs.

In a high-tax state there can be a second reason: S corporations and partnerships can usually elect a pass-through entity tax that gets state income tax around the federal deduction cap. A single-owner LLC taxed by default usually can't.

The downsides

• Payroll. Salary, withholding, quarterly payroll returns and a W-2 — every year.
• A reasonable salary. You can't take it all as distributions. How that's judged.
• A separate tax return for the business, Form 1120-S, which usually costs more to prepare.
• A smaller QBI deduction. Your salary doesn't count toward it. How that works.
• State taxes. Some states tax S corporations or charge minimums — California, for one, takes 1.5% of net income with an $800 minimum.
• What a partnership-taxed LLC gives up: flexible profit splits, counting the business's loans toward your basis, and taking property out without tax.

How to elect

1. Check eligibility: 100 or fewer owners, all individuals who are US citizens or residents (or certain trusts and estates), and one class of ownership.
2. File Form 2553, signed by every owner, within two months and 15 days of the start of the tax year it should take effect — March 15 for a calendar-year business. It also makes the LLC a corporation for tax purposes, so you don't file Form 8832 separately.
3. Set up payroll and start paying yourself a reasonable salary.
4. File Form 1120-S for the business each year, with a K-1 for each owner.

Before you elect: undoing it isn't simple

Owners holding more than half the shares can revoke the election, but then the business generally can't elect again for five years. And revoking it leaves a corporation taxed as a C corporation — getting back to an LLC's default treatment can mean a taxable liquidation. It's worth being fairly sure before you file.

Common questions

• Can a single-member LLC be an S corp? Yes — that's one of the most common setups.
• Do I need to form a new company? No. The LLC files Form 2553; nothing changes with the state.
• Can an S corporation own an LLC? Yes. An LLC wholly owned by an S corporation is usually disregarded for tax — its income is simply part of the S corporation's.
• When should I switch? When profit is comfortably above a reasonable salary for your work, and steady enough that the savings outweigh payroll and the extra return year after year.

More on how S corporations work. Whether your LLC should elect is a question for your CPA or tax attorney before you file anything.