As a single member LLC your entity is considered a “disregarded entity” for federal tax purposes. That means that while you have the limited liability protection afforded an LLC, you are taxed the same as if you were a sole proprietor. All of the profits and losses flow down directly to you as an owner.
One potential downside to this structure is paying the self employment tax on the profits generated by the LLC. However, you have the option of making an S corporation tax election for your entity.
Like a single member or multi-member LLC, an S corporation is considered a pass-through taxation structure.
So why consider the S corporation tax election if they both are pass through entities?
One reason is that by making an S corporation tax election the owner can now make themselves an employee of the entity, pay themselves a reasonable salary (and take note that the IRS is serious that the salary must be reasonable), and take any other profits left over as a distribution. The distributions from an S corporation do not carry any employment related taxes. In comparison all profits in the standard single member LLC setup carry with them self-employment taxes.
While there can be tax advantages to electing to have your LLC taxed as an S corporation, there are limitations on who can be an owner of an S corporation. For example, corporations, partnerships, and nonresident aliens cannot be an owner of an S corporation. Instead, the owners of an S corporation must be U.S. citizens, residents or certain trusts, estates, and tax-exempt corporations (including 501(c)(3) corporations).
To elect S corporation tax status, you must file IRS form 2553. There are limitations for when the election can be made – it must be filed either within 75 days of forming the company or by March 15th to ensure it applies to the current year.
Aspects such as what you must set as a reasonable salary, when the S corporation election will apply, and the added administrative paperwork make filing the S corporation election a decision you should definitely run by your CPA or another tax expert. Simply making the election to avoid self-employment taxes can be an endeavor you’ll later regret as it does not make sense for all single member LLC owners.
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.