S-Corporation Election
Definition
An S-Corporation election is a tax status that an LLC or C-Corporation can request from the IRS. By filing Form 2553, the business asks the IRS to tax it under Subchapter S of the internal revenue code. For an LLC, this changes how the owners pay taxes, but it does not change the fact that the business is legally an LLC under state law.
Why it matters
For highly profitable LLCs, an S-Corp election is a powerful tool to save thousands of dollars a year in self-employment taxes. Normally, an LLC owner pays 15.3% self-employment tax on 100% of the business profit. With an S-Corp election, the owner becomes an employee, pays themselves a "reasonable salary," and takes the remaining profits as a "distribution." The distribution portion is completely free from the 15.3% self-employment tax.
Example
David's LLC makes $100,000 in profit. Under standard LLC taxation, he pays 15.3% self-employment tax on the full $100,000. Next year, David files an S-Corp election. He pays himself a $60,000 salary via payroll and takes a $40,000 distribution. He only pays self-employment taxes (FICA) on the $60,000 salary, completely shielding the $40,000 distribution from those taxes.