Single Member LLCs In Service Industries: Can S-Corporation Election Save You Money?
Jeff Storch | 08.22.22
A single member limited liability company (LLC) often is treated as a disregarded entity for tax purposes (that is, taxed as a sole proprietorship); this is the default rule for an LLC owned by one person. However, if you are the sole owner of an LLC and you perform services for it, you may be able to save on self-employment tax by electing to have the LLC taxed as an S corporation and then becoming the LLC’s employee (you technically can’t be an “employee” if you own an LLC taxed as a disregarded entity – or a partnership).
However, there are several considerations before making such an election, including:
- Being an S corporation would increase tax filing obligations. If the LLC is taxed as an S corporation, you would need to file a Form 1120S for the LLC and have the LLC issue you a Form W‑2 for your wages and also a Form K‑1 if you take any distributions out of the LLC. In contrast, if you left the LLC as a disregarded entity, the LLC would not make its own tax filing, and you simply would report all its income on a schedule to your personal tax return (likely Schedule C).
- You still have to pay yourself a reasonable salary for the services you provide. Therefore, the self-employment tax savings only works if you make enough profit under the LLC that after paying you your salary, you could take out additional money (the aforementioned distributions). You would still pay employment tax on your salary, but distributions beyond your salary are not subject to employment tax.
- How likely are losses? If the LLC operates at a loss, it may be easier to take the loss if it is a disregarded entity rather than an S corporation. This may be of particular concern for start-up LLCs. However, since you can make the S corporation election prospectively, you could start out under the default sole proprietor tax treatment, and if you later have enough profits, you then could elect for the LLC to be taxed as an S corporation for future tax years.
Note that these issues also impact multi-member LLCs whose owners perform services for the LLC. However, because a multi-member LLC by default is taxed as a partnership, it already has to file a tax return for the LLC (Form 1065) and issue Form K‑1 to its owners. Therefore, switching to S corporation taxation does not increase a multi-member LLC’s tax filings as much as for a single member LLC.
If you are considering the S corporation election for your LLC, you and your tax advisors should run through different scenarios to see potential tax savings and compare those savings against the additional filing burdens and other concerns. In addition, you should ensure your LLC’s operating agreement and other applicable governing documents are properly drafted or amended to reflect the election to be taxed as an S corporation.
DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.