Should Your LLC Elect S Corporation Status? The Real Deal

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1. Deep Dive: Should Your LLC Elect S Corp Status? The Real Deal
   (4 min read)

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You’ve probably heard about LLCs electing S corp status. It’s a hot topic for a reason: tax savings. But like any business decision, it’s not a one-size-fits-all solution. Let’s break it down so you can decide whether it’s the right move for you.

Why Consider an S Corp Election?

An S corp election allows your LLC to keep its legal structure but be taxed like an S corporation. This hybrid approach can provide real benefits—primarily self- employment tax savings. But it comes with added complexity. Let’s weigh the pros and cons.

The Upside: Why Business Owners Love S Corps

• Self-Employment Tax Savings: Instead of paying self-employment tax on all profits, you pay yourself a “reasonable salary” (subject to payroll taxes) and take the rest as distributions, which are not subject to self- employment tax. Example: If your LLC earns $100,000 and you take a $80,000 salary, the remaining $20,000 is free from the 15.3% self- employment tax.

• Pass-Through Taxation: Like an LLC, an S corp avoids corporate-level tax. Profits and losses pass through to your personal return.

• Business Growth Appeal: Some investors prefer the S corp structure because of its clear tax treatment and profit distribution.

The Downside: Why Some Business Owners Pass

• More Paperwork & Compliance: S corps must file a separate tax return (Form 1120S, due March 15), run payroll, issue W-2s, hold annual meetings, and maintain corporate minutes.

• IRS Scrutiny on Salaries: Pay yourself too little to dodge payroll taxes, and the IRS may come knocking.

• Ownership Restrictions: No more than 100 shareholders, all must be U.S. citizens or residents, and only certain entities qualify. You also can’t issue multiple classes of stock.

Will S Corp Status Scare Away Investors?

If you plan to seek outside investment (VCs, private equity, or even some banks), your S corp election could create hurdles:

• Venture Capital & Private Equity: Many firms rely on corporate shareholders, foreign investors, or preferred stock—none of which are allowed in an S corp.

• Bank Loans: Banks won’t necessarily care about your tax status, but they’ll scrutinize your financials more closely due to stricter reporting requirements.

Reversing an S Corp Election

If an investor insists you drop your S corp status, you can revoke it by filing a statement with the IRS, signed by shareholders holding over 50% of shares. Just know that once revoked, you’ll need IRS approval to re-elect S corp status within five years.

How to Elect S Corp Status (If It’s Right for You)

If the benefits outweigh the trade-offs, here’s how to make the switch:

1. Check Eligibility: No more than 100 shareholders, all U.S.-based, and only one class of stock.

2. Get an EIN: If your LLC doesn’t have one, apply on the IRS website.

3. File Form 2553: Provide your LLC’s details, effective date, and signatures of all members.

4. Submit the Form: Mail or fax it to the IRS no later than 2 months and 15 days after the start of the tax year in which the election takes effect.

5. State Requirements: Some states require extra filings—check with your state tax authority.

What Changes After Electing S Corp Status?

If you go the S corp route, be ready for a few new obligations:

• Tax Filing: File Form 1120S annually (due March 15). Need more time? Request an extension with Form 7004.

• Payroll: Pay yourself a “reasonable salary,” withhold payroll taxes, and file quarterly payroll tax returns. Consult your CPA on what is “reasonable.”

• Corporate Formalities: Hold annual meetings, keep minutes, and elect and maintain a board of directors (even if it’s just you).

• State Tax Implications: Some states don’t recognize S corp status and may tax you differently (e.g., California’s 1.5% franchise tax on S corp income). Consult with your CPA before electing S corp status if your LLC is located in California, District of Columbia, New Hampshire, Tennessee, New York City, Texas, or Louisiana.

A Holding Company Advantage: Cleaner Cap Tables, Smoother Deals

In a related strategy for streamlining your business, consider using an S corp as a holding company. As detailed in one of our recent articles, Want Outside Capital? You Need a Holding Company, consolidating ownership under one holding entity simplifies your cap table dramatically.

Instead of juggling a maze of individual shareholders—from founders to early employees and advisors—the holding company presents a single, clean face to potential investors. This means less due diligence work, fewer red flags, and a more flexible approach to internal equity adjustments.

With one tax return for the holding company and enhanced protection from personal liabilities, this structure not only streamlines administration but also paves the way for smoother transitions during PE or VC investments.

Integrating the S corp election into a holding company framework can amplify these benefits, merging tax efficiency with an investor-friendly, uncluttered equity structure.

Interested in learning more? Read TCoL article, Want Outside Capital? You Need a Holding Company [here].

Decision Time: Should You Elect S Corp Status?

Elect S Corp If:

✔ Your LLC earns enough to justify self-employment tax savings. 
✔ You don’t plan on taking VC or PE funding soon. 
✔ You’re okay with added administrative work.

Stick with Default LLC Taxation If:

✖ Your profits are low, making tax savings minimal.
✖ You plan to raise VC or PE funding.
✖ You prefer a simpler tax and governance structure.

Final Thought: Talk to a Pro Before Making the Call

Electing S corp status can provide major tax advantages, but it’s not for everyone. Before making the leap, talk to a CPA or tax attorney to run the numbers and align your tax structure with your long-term business goals.

Getting it right today can save you headaches (and money) down the road.

Have an interesting business question and need a free bit of advice? Send your question to [email protected]. No confidential info, please!