Like many entrepreneurs, you may have elected to file your business structure as a Limited Liability Company (LLC) and I’m sure you know that LLCs can elect to be taxed as corporations by filing IRS Form 8823, and then elect to treated as a “Sub-Chapter S Corporation.” Although the IRS has granted this choice to avoid the pitfall of “self-employment” tax, as normally experienced by members in a LLC, there are additional concerns that business owners need to explore before pulling making this election.
First, by electing to be taxed as a “S-Corporation”, the business (LLC) will be held to the filing requirements, tax consequences and regulations applied to corporations, despite the fact that the business is still being governed by state law that applies to LLCs. In some cases, this leads to uncertainty as to “which law” applies, and many business owners may not realize that they need to adhere and meet the reporting and filing requirements required of S-Corps. In addition, there are strict eligibility requirements applied to shareholders that are not applied to the members. Furthermore, failing to meet the eligibility requirements may lead to the “S” election being terminated by the IRS.
Secondly, by selecting to be taxed as an S-Corp the members need to cautiously establish the management system so that it doesn’t violate the corporate eligibility requirements or cause confusion and ambiguity with those that do business with the LLC. Generally, LLC’s are either “Member Managed” or “Manager Managed” and don’t have vertical management structures like corporations. This is done intentionally to avoid unnecessary layers of “bureaucracy” in small closely held companies. However, if the LLC elects to be treated and taxed as a corporation, the management structure generally takes on the look and feel of a corporation with members being appointed titles such as “CEO, President, Directors, etc…” and empowered to make decisions which are not clearly defined in the operating agreement. Unfortunately, most business owners, or their representing CPAs and attorneys, don’t build-in the necessary enumerated powers and checks and balances to ensure that the management system will operate like a corporation and avoid potential confusion.
Although this election process has become popular by CPAs and some lawyers for simplicity and tax saving purposes, these other “ancillary” issues, like management, need to be explored on a case-by-case basis prior to making the election, to ensure it’s the best fit for your business.Share this Article