S-Corporation Tax Status

A limited liability company can easily elect to be taxed as a Subchapter “S” corporation (commonly known as S-Corporation). By doing so, the LLC would be a “flow through” entity meaning that it does not file a tax return or pay any taxes at the entity level. Instead, the income (or losses) for the LLC would flow through the entity directly to its owners (called “members”) and would be included in their taxes.

Reasons to choose S-corporation taxation for single-member LLCs

The most common reason to choose S-corporation taxation for single-member LLCs is to reduce payroll taxes. Specifically, it is possible to divide company income into W-2 income and dividends so as to reduce the amount of Self-Employment taxes that the owner is liable for. This is because W-2 income is subject to Self-Employment taxes whereas dividends are not. The IRS requires that S-corporation working owners be paid a “reasonable salary.” Therefore, the usual strategy for reducing taxes is to have the single-member owner of the LLC receive a “reasonable” salary based on what is commonly paid to others in the industry and pay our the remainder of the company’s income to the single-member owner as dividends. The result of this approach can be thousands of dollars in tax savings. One caution: if you are considering this tax-savings approach, be warned that the determination of what a “reasonable salary” is very important and setting one that is too low risks the IRS reclassifying dividend income as W-2 income and assessing penalties. Therefore I always recommend that you work with your accountant on deciding whether S-corporation tax status is right for you. 

A few reasons NOT to choose S-corporation taxation for single-member LLCs

There are a few reasons why single-member LLCs should NOT choose S-corporation taxation. These include:

  • For tax reasons, real estate should NEVER be held by an entity choosing S-corporation taxation
  • S-corporation taxation means that owners cannot take advantage of certain tax benefits such as setting up a Health Reimbursement Arrangement
  • S-corporation taxation means that the LLC cannot be owned by a legal entity – it needs to be owned by the owner as an individual. This makes it impossible to hold the LLC through a holding company or other LLC – something that is common with some more sophisticated asset protection or wealth planning structures.