An LLC can elect to be taxed as an S corporation during the year, but the tax consequences and filing requirements depend on when the election is effective and whether the LLC is single-member or multi-member.
1. Tax implications
Before the S election effective date
- Single-member LLC: Income is generally reported on the owner's Schedule C (unless another classification applied).
- Multi-member LLC: Income is generally reported on Form 1065, with Schedule K-1s issued to members.
After the S election effective date
- The LLC is treated as an S corporation for federal tax purposes.
- Business profits and losses flow through to shareholders via Schedule K-1.
- Shareholder-employees must receive reasonable compensation subject to payroll taxes before taking shareholder distributions.
- Distributions in excess of reasonable compensation are generally not subject to self-employment tax, making S corporation status potentially advantageous for some businesses.
2. Filing requirements
The election is made by filing Form 2553, Election by a Small Business Corporation. Generally, the election must be filed:
- No later than 2 months and 15 days after the beginning of the tax year in which it is to take effect, or
- During the preceding tax year for a next-year election. Late-election relief may be available if the requirements under Rev. Proc. 2013-30 are met.
Depending on the effective date:
-
Single-member LLC
- File Schedule C through the day before the S election.
- File Form 1120-S for the remainder of the year.
-
Multi-member LLC
- File a short-period Form 1065 through the day before the election.
- File a short-period Form 1120-S beginning on the election effective date.
The S corporation return (Form 1120-S) includes Schedule K-1s for each shareholder.
3. Payroll considerations
Once the S election is effective:
- Owners performing services should be added to payroll.
- Payroll tax filings (Forms 941, 940, W-2, state payroll returns, etc.) begin as of the effective date.
- Owner draws taken after the election may need to be recharacterized between wages and shareholder distributions as appropriate.
4. Accounting considerations
The books should clearly separate:
- Income and expenses before the election, and
- Income and expenses after the election.
Assets, liabilities, and equity generally carry over, but shareholder stock basis should be established at the S corporation conversion date.
5. State tax considerations
Some states:
- Automatically recognize the federal S election.
- Require a separate state S election.
- Impose entity-level taxes or franchise taxes on S corporations.
State-specific rules should be reviewed before making the election.
Planning note
For many clients, a mid-year S election creates additional complexity because it can require:
- Two short-period federal returns,
- Payroll setup mid-year,
- Allocation of income and expenses between periods, and
- Additional state filings.
Unless there is a compelling reason (such as significant tax savings or a business acquisition), practitioners often compare the benefit of a mid-year election with waiting until January 1 of the following year, when administration is generally much simpler.
