How to Choose a Tax Classification for Your LLC

Default Tax Classification

By default, an LLC is a pass-through entity:

• Single-member LLC: Taxed as a sole proprietorship.
• Multi-member LLC: Taxed as a partnership.

Income passes through to the members' personal tax returns, and the LLC itself does not pay federal income tax. Members in this default setup are subject to self-employment taxes.

LLCs can also elect to be taxed as a corporation if it makes financial sense.

S-Corp Status

S-Corp status allows the LLC to remain a pass-through entity, avoiding corporate taxes while reducing self-employment taxes. To qualify, your LLC must:

• Be domestic.
• Have only eligible shareholders (individuals, certain trusts, estates).
• Have no more than 100 shareholders.
• Have only one class of stock.
• Not be an ineligible corporation (certain financial, insurance, or international sales companies).

Members are treated as employees and receive a salary, which requires payroll and accounting. S-Corp status is beneficial when the tax savings outweigh these added expenses. Election is made by filing IRS Form 2553.

C-Corp Status

Electing C-Corp status can make your business more attractive to investors since corporate shares are easier to transfer than LLC membership percentages. Benefits include:

• No self-employment taxes.
• Ability to provide tax-free employee benefits such as health insurance.

However, C-Corp taxation comes with corporate taxes, personal income taxes on salaries, payroll taxes, and taxes on dividends. Filing IRS Form 8832 is required to elect C-Corp status.

Choosing the Right Classification

• Use default LLC taxation for simplicity and straightforward pass-through taxes.
• Consider S-Corp if your LLC generates enough income to save significantly on self-employment taxes.
• Consider C-Corp mainly for raising investment or offering employee benefits, rather than for tax savings.