How Are LLCs Taxed in Alabama?
From Tax Guide.
Tax Guide · Arab, Alabama
LLC or S Corporation: How the Tax Difference Works
S corp vs LLC explained: what an S corporation election is, why reasonable salary matters, and what to weigh before an LLC owner asks to elect S status.
The short answer
What is the difference between an LLC and an S corporation?
An LLC is a legal structure created under state law, while an S corporation is a federal tax election, and the two are not opposites: an LLC can choose to be taxed as an S corporation.
People often ask "S corp vs LLC" as though they must pick one or the other. In practice you decide how the business is organized under state law, and then how the IRS taxes it. Our guide on how LLCs are taxed in Alabama explains the default rules.
By default, a single-member LLC is taxed on the owner's personal return and a multi-member LLC is taxed as a partnership. An S corporation election changes how the income is reported and how the owner gets paid, and it comes with added requirements.
How it works
What does an S corporation election change?
It changes the tax treatment: the business files its own return, Form 1120-S, and profits pass through to the owners, who are taxed on them personally.
To make the election, the business files Form 2553 with the IRS by a deadline the IRS sets. The business must meet eligibility rules, such as limits on who can own shares and on classes of stock. Not every business qualifies, and an election filed without checking the rules can be invalid.
The biggest practical change is that owners who work in the business are treated as employees. Payroll, withholding and payroll tax filings become part of the picture, which is why a switch is more than a form.
| LLC (default tax treatment) | LLC or corporation taxed as an S corporation | |
|---|---|---|
| Business return | None (single owner) or Form 1065 (multiple owners) | Form 1120-S |
| Owner pay | Draws from profit | Wages through payroll, plus distributions |
| Self-employment tax | Generally on the net profit | Applies to wages, distributions are treated differently |
| Extra paperwork | Lighter | Payroll, W-2, Form 941, state filings |
This is a general comparison. Whether it helps depends on the facts of your business.
Owner pay
What is a reasonable salary for an S corporation owner?
A reasonable salary is the pay an S corporation owner who works in the business should receive as wages for the services they perform, before taking any additional distributions.
The IRS looks at the duties of the owner, the time spent, what similar businesses pay for similar work, and the profitability of the company. Paying an owner very little in wages and taking most of the money as distributions is a known audit issue. The wages are subject to payroll taxes, and that is part of the cost of the election.
There is no single formula, and we do not want to give a number that fits everyone. A tax professional can help you document how the salary was chosen. Our guide to payroll taxes shows what has to be withheld and paid on those wages.
Weighing it
When might an S corporation election make sense?
It may be worth a look when the business earns steady profit beyond what a fair salary would be, but it also adds cost and rules, so it is not right for everyone.
Some owners find the payroll and filing work is more than the benefit. Others find it fits well once the business is established. It is not a way to avoid Social Security and Medicare on the owner's work, and the IRS pays attention to that.
- Payroll must be set up and run, with tax deposits and quarterly returns
- A separate business return is required every year
- Owner wages are taxed, even in a year when the business is slow
- Alabama has its own rules for S corporations, and we check how they apply
- Losses and basis rules are more complicated than for a sole proprietor
Timing
How and when do I elect S corporation status?
You file Form 2553 with the IRS, and it generally must be filed within a window set by the IRS, so timing matters.
Late elections are sometimes accepted with a showing of reasonable cause, but it is much easier to plan ahead. Every owner must consent, and the entity must meet the requirements from the date the election is to begin.
If you are still deciding whether to form an entity at all, or choosing a structure for a new business, read our starting a business tax checklist. For a look at how your yearly tax picture may change, see tax planning for small business owners.
Compliance
What must an S corporation file each year?
Each year an S corporation files Form 1120-S and issues Schedule K-1s to its shareholders, and if it has employees it also files payroll returns.
The owners report the K-1 amounts on their personal returns. Wages are reported on Form W-2, and the business generally files a quarterly payroll return and makes tax deposits on a schedule the IRS assigns. State returns may also be required. Missing these filings can bring penalties, so the recurring workload is a real factor in the decision.
For a plain list of the returns each business type files, see business tax return types.
How we can help
How Melton Tax Services can help you decide
Our tax planning service can walk through how your business is structured and how an S corporation election could change the way you are taxed.
Through tax planning and consulting, we look at your numbers with you and explain the trade-offs, so you can decide with clear information. We do not form LLCs or corporations, but we can talk through how a structure fits the tax side, and we can prepare the returns that follow.
We serve Arab and the surrounding area. Call 256-586-4635 or use our contact page. Bring your paperwork to the office, and please do not send Social Security numbers or documents through the website.
Answers
Questions about llc vs s corp
Is an LLC or an S corporation better for taxes?
Neither is better in every case. The right answer depends on profit, payroll costs, your goals and your state rules. We look at the facts before anyone decides.
Can an LLC be taxed as an S corporation?
Yes, an eligible LLC can file an election to be taxed as an S corporation. It remains an LLC under state law while being taxed differently federally.
Do S corporation owners have to run payroll?
Owners who work in the business generally must be paid reasonable wages through payroll, with withholding and payroll tax filings. Payroll is one of the main added tasks.
What is Form 2553?
It is the form used to elect S corporation status with the IRS. It has a deadline, and all shareholders must consent.
Does an S corporation avoid self-employment tax?
Not entirely. Owner wages are subject to payroll taxes, and the IRS expects owners to be paid a reasonable wage. Distributions above that are treated differently, but the rules are specific.
Can I go back to being a regular LLC after electing S status?
It is possible, but revoking an election has rules and waiting periods before another election. Think through the decision carefully before starting.
Read next
Related reading
Which Business Tax Return Do I File?
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Payroll Taxes Explained: FICA, Withholding and More
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Tax Planning for Small Business Owners
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Tax Planning
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