Just as a LLC can elect to be taxed as a C-corporation, it can also easily elect to be taxed as a C-corporation. Unlike S-corporation tax status, C-corporation tax status means that the LLC is taxed BOTH at the corporate level AND at the owner level. This is commonly known as “double-taxation” and is one reason why most single-owner LLCs do not choose C-corporation status. To illustrate, if a C-corporation taxed LLC makes a net profit of $250,000 in a given year, it would have to pay corporate tax on the $250,000 in profit. Then, whatever amount is leftover after paying taxes can be used to either be invested back into the corporation or paid out to owners (members, in the case of LLCs) as dividends. However, when the owners receive dividends, they would again pay taxes on those dividends.
One way that some C-corporation taxed entities minimize the double-taxation problem is by paying out most of their net profit as W-2 compensation to owners. This is because W-2 compensation is a deduction that C-corporation taxed entities can take against their income to reduce their net taxable profit. Taking the above example, if the entity was expecting a year-end profit of $250,000, it could pay most or all of this out to a working owner as W-2 compensation. The working owner would have to pay taxes on the compensation but it could significantly reduce, or even eliminate the corporation’s profit so that there would be no corporate tax due. One caution here is that the IRS requires that W-2 compensation paid out to working owners of C-corporation taxed entities be “reasonable” meaning, in this case, that it can’t be too large. If the working owner provides low skilled work to the company or works very little, then, for example, the $250,000 W2 compensation could be deemed unreasonable and reversed, resulting in reassessed taxes and penalties on the corporation. If you are planning to elect C-corporation tax status, I recommend that you work with your accountant to properly set your compensation rate to ensure tax compliance.
Reasons why single-owner LLCs choose C-corporation tax status
The biggest reason why single-owner LLCs choose C-corporation tax status is to access certain tax benefits that aren’t available to LLCs taxed either as disregarded entities or S-corporations. This is because, as a C-corporation taxed LLC the single-owner is considered an employee of the LLC. Examples of the tax benefits that this can provide include Health Reimbursement Arrangements, and fringe benefits such as tax-free health insurance premiums.
Other reasons for choosing Corporation tax status include the ability to retain earnings while only paying the (currently) low corporate tax rate (especially if the owner’s personal tax bracket is particularly high) and the ability to carry over losses into future years (a more sophisticated tax-planning move).