Ohio LLC vs. S corp: one is an entity, the other is a tax election

Is an S corp a business entity or a tax election?

An S corp is a tax election. There is no "S corporation" box on any Ohio Secretary of State form, and Ohio has no S corp entity type to file. The phrase describes how the IRS taxes a company that has elected under Subchapter S of the Internal Revenue Code.

An LLC is a legal entity. In Ohio it is created when the Secretary of State files Articles of Organization (Form 610) for $99, and Chapter 1706 of the Ohio Revised Code governs it: how members own it, how it is managed, and the rule that members are not liable for its debts solely because they are members (ORC 1706.26).

So "LLC vs. S corp" is not really a choice between two things. The real questions are:

• Which entity do you form in Ohio: an LLC or a corporation?
• How do you want that entity taxed by the IRS: its default classification, or as an S corporation?

An Ohio LLC that files Form 2553 is still an LLC on the state record. Its name, its operating agreement, its members, and its Ohio statutory agent all stay the same. What changes is the federal tax return it files and how its owners get paid.

How is an Ohio LLC taxed with and without an S corp election?

The IRS classifies an LLC with one member as disregarded from its owner and an LLC with two or more members as a partnership, unless the LLC elects otherwise. Filing Form 2553 moves it to S corporation treatment, and the IRS instructions say an eligible entity that makes the S election does not also need to file Form 8832.

The ownership limits come from the IRS's S corporation rules: a domestic corporation (or eligible entity treated as one), no more than 100 shareholders, only allowable shareholders, and only one class of stock. An LLC with a corporate member or a foreign owner who is a nonresident alien cannot make the election.

Where S corp tax savings come from: wages vs. distributions

In a default LLC, the owner's whole share of net earnings is subject to self-employment tax: 15.3%, made up of 12.4% for Social Security and 2.9% for Medicare. That is the tax most owners are trying to reduce when they ask about an S corp.

With an S election, an owner who works in the business is an employee. The LLC pays that owner a wage through payroll, and Social Security and Medicare taxes apply to the wage. Profit left after the wage can be paid out as a distribution, which is not wages and is not subject to those payroll taxes.

A simple illustration: an LLC earns $100,000 in profit, and the owner takes a $60,000 salary. Payroll taxes apply to the $60,000. The other $40,000 passes through as a distribution. Income tax still applies to all of it on the owner's returns. Whether that leaves you ahead depends on the salary being defensible and on what payroll, an extra tax return, and accounting fees cost you. Those numbers are for your accountant to run with your figures, not ours.

What is a reasonable salary for an S corp owner?

The IRS says an S corporation must pay reasonable compensation to a shareholder-employee for services before making non-wage distributions. It also says the IRS has authority to reclassify distributions as wages, and that to the extent gross receipts come from the shareholder's personal services, those payments should be treated as wages subject to employment taxes.

The IRS lists factors it looks at when deciding what is reasonable:

• Training and experience
• Duties and responsibilities
• Time and effort devoted to the business
• Dividend history
• Payments to non-shareholder employees
• Timing and manner of paying bonuses to key people
• What comparable businesses pay for similar services
• Compensation agreements
• The use of a formula to determine compensation

There is no IRS percentage or safe-harbor number. An owner who pays themselves a token wage and takes the rest as distributions is the pattern the IRS describes. Set the salary with a CPA who knows your industry and can document how the figure was reached, and revisit it as the business changes.

What does an S corp election add to running an Ohio LLC?

The election saves tax only after it covers its own costs. Plan for these:

• Payroll for every owner who works in the business: withholding, deposits, quarterly federal payroll returns, and W-2s at year end.
• Ohio employer registration. Once the LLC pays wages, ORC 5747.06(A) requires it to withhold Ohio income tax. Our guide to Ohio employer withholding registration covers the account and filings.
• Local withholding. Ohio cities with an income tax have their own withholding rules for wages; see Ohio municipal income tax for businesses.
• A separate federal return, Form 1120-S, with a Schedule K-1 for each owner, in place of the owner's Schedule C or the partnership return.
• Accounting fees for payroll and the added return, which a CPA can quote before you elect.
• Tighter profit sharing. With one class of stock, distributions follow ownership percentages. Special allocations that a multi-member LLC's operating agreement might allow do not carry over.

None of this touches the state business record. The LLC files nothing with the Secretary of State to become an S corp, and nothing about its statutory agent changes.

How does Ohio tax an LLC that elects S corp status?

Ohio taxes an S corporation's profit through its owners. ORC 5733.04(O) defines a "pass-through entity" to include an entity that has made a Subchapter S election, along with LLCs and partnerships that are not taxed as corporations. Income passes through to the owners and is taxed on their Ohio personal returns.

For individual owners, Ohio allows a business income deduction of up to $250,000 ($125,000 for each spouse filing separately) under ORC 5747.01(A)(28), and ORC 5747.02(A)(4) taxes business income above that at 3%. How Ohio sorts an owner's S corp wages and distributions for that deduction is a detail to confirm with your accountant before you count on a particular result.

Some Ohio taxes are unaffected by the election:

• The Ohio Commercial Activity Tax is based on gross receipts, not entity type or tax classification, and applies above $6 million a year in Ohio taxable gross receipts.
• Sales tax depends on what you sell.
• Municipal net profit tax follows city rules, which treat pass-through entities in their own way.

Ohio law also lets a pass-through entity elect to pay tax at the entity level (ORC 5747.38), and has withholding rules for certain investors (ORC 5747.41). Whether either applies to your LLC is a question for your CPA. For the full list of taxes an Ohio LLC may face, see Ohio LLC taxes.

When does an S corp election make sense for an Ohio LLC?

Accountants tend to raise the question when most of these are true:

• The LLC has steady profit well beyond what a reasonable salary for the owner's work would be.
• The owners work in the business and are willing to run real payroll.
• Every owner is an individual (or an eligible trust or estate) who can be an S corp shareholder.
• The owners are fine splitting profit strictly by ownership percentage.

It usually waits when:

• The business is new, losing money, or profit swings widely year to year.
• Profit is small enough that payroll and accounting costs would eat the savings.
• The members want flexible profit allocations under their operating agreement.
• An owner is a corporation, a partnership, or a nonresident alien.

This is a tax decision with your numbers in it. We file the election when you ask, but we don't advise on whether to make it. A single-member Ohio LLC owner and a five-member LLC face very different math.

How and when an Ohio LLC files the S corp election

The election is made with the IRS, not the State of Ohio. The LLC files Form 2553, signed by all shareholders, no more than 2 months and 15 days after the beginning of the tax year the election is to take effect. For a new LLC, that clock starts with its first tax year, so a late start on the paperwork can push S treatment to the following year. Late-election relief exists in some situations; your accountant can tell you whether you qualify.

Nothing is filed with the Secretary of State. The Articles of Organization are not amended, and the LLC keeps its EIN. Our S corp election filing service prepares Form 2553 once you and your accountant have decided to elect, collects every owner's signature, and puts the IRS acceptance letter in your portal when it arrives.

Common mistakes after an Ohio LLC elects S corp status

Most S corp problems for small LLCs come from treating the election as a one-time form instead of a different way of running the business. Watch for these in particular:

• Filing Form 2553 and never starting payroll. Taking all the money as distributions with no wage is the exact pattern the IRS says it can reclassify.
• Missing the 2 months and 15 days window for a new LLC, then assuming S treatment applies anyway. Check the IRS acceptance letter before you run the first payroll.
• Adding a member who cannot be a shareholder, such as another company. An S corporation that stops meeting the eligibility rules loses its status, so check before you sell or give away any part of the LLC.
• Paying owners distributions that don't match their ownership percentages. With one class of stock allowed, uneven payouts raise questions your CPA will want to fix quickly.
• Forgetting state and local payroll accounts. Federal payroll alone is not enough once wages are paid to someone working in Ohio.
• Expecting the Ohio Secretary of State record to say "S corp." It never will. The state record shows an LLC, and that is correct.

A short call with your accountant each year about salary and distributions heads off most of these.

Should you form an Ohio LLC or a corporation if you want S corp taxes?

Both can elect. An Ohio for-profit corporation is formed under Chapter 1701 and has shareholders, directors, officers, and bylaws. An LLC is formed under Chapter 1706 and is run by its operating agreement. The tax result after a valid S election is the same federal return, Form 1120-S.

The practical differences are in governance and flexibility. An LLC's operating agreement can be simpler than corporate bylaws and minutes, and the members can set management terms to suit themselves. A corporation may suit owners who expect outside investors or want a traditional board structure. Both pay $99 to form in Ohio and both must keep a statutory agent on record (ORC 1706.09 for LLCs, ORC 1701.07 for corporations). The full comparison is in Ohio corporation vs. LLC.