Remember from our earlier article that an LLC defaults to being taxed as a sole proprietor of there's a single member and defaults to being taxed as a partnership if there are multiple members? Well, a single member LLC and a multi-member LLC can elect S-Corporation taxation, by filling out the appropriate forms.
However, a non-lawyer service (and frankly, many lawyers) does not realize that by leaving in default language in their forms, that it can completely disqualify an LLC's status as an S-Corporation. Often, certificates of formation and company agreements contain language that automatically disqualifies the LLC as an S-Corp! Precise drafting is needed to preserve the LLC's S-Corp tax status!Among other things, S-Corps have to have similar capital contributions in the same ratios as their sharing percentages at formation. That's another common disqualification: two Members form an LLC taxed as an S-Corp, and only one puts in money and the other puts in zero. That's not allowed for an entity taxed as an S-Corp; but, would be perfectly legal under an LLC taxed as a partnership. Is your non-lawyer service going to walk your through those steps to protect the status? I doubt it.
In reality, the IRS likely won't know about the mistakes in your company agreement; until you get audited! S-Corps are typically audited at higher rates than partnerships due to the tendency of owners to pay insufficient salaries. If the IRS discovers this discrepancy at audit time, they may go back through years of your taxes, and argue (and win) that you should have paid self employment taxes on all sums that you took as distributions! This can be a huge tax bill to you! All because you wanted to do-it-yourself, or use a lawyer who was not experienced enough with the S-Corp rules.
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Law Office of James Ryland Miller, PLLC
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