Default LLC vs S-Corp Election

When starting a business, one of the first decisions you’ll face is choosing your legal and tax structure. Many small business owners form a Limited Liability Company (LLC) because of its flexibility and liability protection. But there’s another choice to consider: whether to stick with the default LLC taxation or make an S-Corp election with the IRS.

Here’s what you need to know about both options:

1. Default LLC Taxation

By default, a single-member LLC is treated as a disregarded entity and reports income and expenses on the owner’s personal tax return (usually on Schedule C). Multi-member LLCs are taxed as partnerships and file Form 1065, passing income and expenses through to the members. In both cases, all net earnings are generally subject to self-employment tax.

2. S-Corp Election

An S-Corp is not a separate legal entity but a tax election made by filing Form 2553 with the IRS. With this election, LLC owners (or corporations) can pay themselves a reasonable salary and take remaining profits as distributions. The salary is subject to payroll taxes, but distributions are not—potentially reducing self-employment taxes.

3. Taxes: Key Differences

• Default LLC: All profits are generally subject to self-employment tax.

• S-Corp Election: Only the salary is subject to payroll taxes; distributions may avoid self-employment taxes if structured correctly.

  
  

4. Compliance Requirements

LLCs without an election are simpler to run. Electing S-Corp status requires additional compliance: running payroll, filing separate tax forms, and following IRS rules about reasonable compensation and shareholder eligibility.

5. Which One Fits Your Business?

• Stick with default LLC taxation if your business is new, earns modest income, or you prefer minimal compliance.

• Consider the S-Corp election if your business generates consistent profits that justify payroll, and you want potential self-employment tax savings.

  
  

Final Thought

Both LLCs and the S-Corp election provide liability protection and pass-through taxation. The right choice depends on your income, growth plans, and comfort with compliance. Consulting with a CPA ensures you make the decision that best supports your long-term goals.