S Corporation Election & Your LLC
March 15th is the deadline for many LLCs to make the S corporation election. Before making the S corporation election for your LLC, you must first determine whether your LLC qualifies to make the election. Two typical reasons LLCs do not qualify to make the S corporation election are (1) the LLC is owned by an entity other than an individual, or (2) the LLC has more than one class of membership interest.
S Corporation Election Qualification
In order for your LLC to qualify to make the S corporation tax election (i) it may not have more than 100 members, (ii) each member must be an individual, a certain type of trust, or a certain type of organization, (iii) no member may be a non-resident alien, and (iv) the LLC may have only one class of membership interest. Additionally, each member must consent in writing to the LLC’s S corporation election. (If you make the S corporation election, each member of your LLC will become a “shareholder” for tax purposes, and each shareholder will own shares in the S corporation rather than a membership interest.) Certain types of insurance companies and financial institutions may not make the S corporation election.
Most LLCs have less than 100 members, and most LLCs are owned by U.S. citizens. As such, these factors will not disqualify most LLCs from making the S corporation election. However, a fair number of LLCs are owned by entities other than individuals, such as other LLCs, corporations, trusts or partnerships. An LLC owned by just one of these types of entities can disqualify it from making the S corporation election. Your attorney or CPA can likely tell you whether certain types of owners might disqualify your LLC from making the S corporation election.
Additionally, many multi-member LLCs have different classes of members. Generally, if the LLC makes distributions to its members based on differing criteria, regardless of whether the distributions are to be made from the profit earned by the LLC or upon liquidation of the LLC, then the LLC probably has different classes of membership interests, which might disqualify it from making the S corporation election. Likewise, if the S corporation later decides to issue private securities, it will be limited to issuing the same type and class of securities to all shareholders, including the founders. This could be a problem, as investors typically want to be paid a return on their investment in preference to the founders and other preexisting shareholders of the S corporation. The rule against the S corporation having more than 100 shareholders can also be a problem if you are planning to issue securities to a large number of investors, not to mention also raising issues related to the Investment Company Act of 1940. So think twice about making the S corporation election if you are considering a securities offering by your S corporation.
S Corporation Election Timing
If you want your LLC to be taxed as an S corporation beginning in the year in which the S corporation election is made, then you must file your election with the IRS within two months and fifteen days of the first day of the taxable year of the S corporation. Determining the “taxable year” of the S corporation and the exact dates that make up this two month and fifteen day election period can be tricky in some circumstances. As explained below, if you file your S corporation election just one day late, then your S corporation election may be delayed by at least one year. Consult your attorney or CPA if you are unsure about how these dates apply to your LLC’s S corporation election.
Most LLCs use the calendar year as their tax year. As such, the taxable year for most LLCs will likely end December 31st. If the taxable year of your LLC ends on December 31st, then you likely must file the S corporation election for your LLC by March 15, 2015, if you want your LLC to be taxed as an S corporation in 2015. If you file the S corporation election with the IRS on March 16, 2015, or any day in 2015 that is later than March 15, 2015, then your LLC will not be taxed as an S corporation until 2016.
Likewise, if you want your new LLC to be taxed as an S corporation beginning in the same year in which the LLC is organized, then you must file the S corporation election with the IRS within two months and fifteen days of the first day of the first taxable year of the new LLC. As with many aspects of the laws and regulations related to the S corporation election, determining this first day can be tricky. Generally, this first day is (i) the first day on which the new LLC has members, (ii) the first date on which the LLC first acquires assets, or (iii) the day on which the LLC first starts to conduct business, whichever occurs first.
As an example, if the first day of the first taxable year of your LLC is April 9th, you must make the S corporation election by June 23rd of that same year in order to qualify to be taxed as an S corporation beginning in the first year of the LLC. As a general rule, try to not make the S corporation election for your new LLC too early or too late. The S corporation election will be invalid if you mistakenly file the S corporation election with the IRS prior to the first day of the first taxable year of the LLC. Likewise, you will have to wait a year to be taxed as an S corporation if you make the S corporation election too late. (If you fail to make the S corporation election within the two month and fifteen day election period, the IRS could permit you to make a late election for “reasonable cause”. However, applying for a late election with the IRS is obviously a hassle you are better off avoiding if possible.)
As with making the S corporation election, a revocation of an S corporation election must be made within two months and fifteen days of the first day of the taxable year of the S corporation in order for the S corporation to not be taxed as an S corporation beginning in the year in which the revocation is filed with the IRS. For example, if the taxable year of your S corporation ends on December 31st, then you must make the S corporation revocation election by March 15th for the revocation to be effective for that taxable year. If you miss the deadline, the revocation will likely not become effective until the next year. Because you will likely have to live with the S corporation election for at least one year, you should carefully consider whether the S corporation election is proper for your LLC before making the S corporation election.
S Corporation Election Take-Aways
This article touches on just a few of the things to consider when deciding whether to make the S corporation election for your LLC. Additional key considerations include the amount of “reasonable compensation” you decide to receive from the S corporation and the tax liability you will likely incur on the income that you receive from an S corporation. The amount of money that you save by not having to pay the self-employment tax (FICA tax) on dividend distributions that you receive from the S corporation may not outweigh the other tax liabilities that you might incur by making the S corporation election. Prudent planning will help you make the right decision.
This article was published on February 26, 2015.
The information contained in this article is general in nature, and it is not intended as legal advice. Your circumstances may be unique, and you should therefore consult knowledgeable legal counsel regarding how the information or concepts discussed in this article might apply to you or to your business.
Michael Sewell has a Masters degree in Business Administration, numerous years of high level business experience, and he has practiced law in Missouri since 2005. Michael is the owner of Sewell Law, LC, d/b/a Sewell Law, which provides legal advice to Missouri business owners.
Please contact Michael at 314.261.7528 for a free initial consultation, or at michael@stlouisllcattorney.com. You can obtain additional information at www.stlouisllcattorney.com.
