S-Corp Election for Illinois LLCs and Corporations: When It Saves Tax and How to File

The election pays off when three things are true: the business makes a profit comfortably above what a reasonable salary for the owner's work would be; the owners are all eligible shareholders and will remain so; and the business can absorb the cost and discipline of running payroll and filing a corporate return. A consultant, a contractor, a dental practice or a shop with steady profit well above the owner's market salary is the typical candidate.

The election usually does not pay off for a business with modest or irregular profit, one that will bring in an investor who wants preferred stock or an entity owner, one whose owners live abroad, or a rental real-estate holding, where the income is not self-employment income and an S election adds cost for no saving. The entity selection page sets the S corporation beside the LLC default and the C corporation. The business attorney hub covers the firm's other work for small companies.

The costs belong in the arithmetic too: Form 1120-S with a Schedule K-1 for each owner and Illinois Form IL-1120-ST, so the owner's personal return waits for the corporate return; the 1.5 percent Illinois replacement tax, which a sole proprietor or single-member LLC does not pay; health insurance for a more-than-2-percent owner run through payroll; retirement-plan contributions calculated on W-2 wages rather than total profit; and fringe benefits that a C corporation can provide tax-free but an S corporation largely cannot.

For the election to take effect for a tax year, Form 2553 must be filed no more than two months and fifteen days after the beginning of that tax year, or at any time during the tax year before it. For a calendar-year business the deadline is March 15. For a new company the first tax year begins when it first has owners, acquires assets or starts doing business, so a company formed on, say, August 20 has until early November to elect for its first year.

An election filed after the deadline is generally effective for the following tax year. That is a full year of self-employment tax that cannot be recovered, which is why the decision belongs in the formation meeting rather than at tax time.

The election comes with an obligation that undoes the saving if ignored. The IRS position, upheld in a line of court decisions, is that distributions and other payments by an S corporation to a shareholder who performs services must be treated as wages to the extent they are reasonable compensation for those services. An owner who draws a nominal salary and takes the rest as distributions invites reclassification of the distributions as wages, with employment tax, penalties and interest.

There is no safe-harbor percentage. The factors are the owner's training and experience, the duties performed, the time devoted to the business, what comparable businesses pay for comparable work, what the company pays non-owner employees, and the history of distributions. The practical method is to document the salary decision each year with reference to market data for the owner's role, and to set it as a corporate resolution in the minutes.

Payroll itself means registering as an employer with the IRS, the Illinois Department of Revenue and IDES, withholding each pay period, filing quarterly Form 941 and Illinois withholding returns, paying unemployment tax, and issuing the owner a W-2. Most companies use a payroll service; the cost is part of the break-even.

Illinois follows the federal S election. The company files Form IL-1120-ST and pays the personal property replacement tax at 1.5 percent of net income; the shareholders pay Illinois income tax at 4.95 percent on their shares. For tax years ending on or after December 31, 2021, an S corporation may also elect on its IL-1120-ST to pay the Illinois pass-through entity tax at 4.95 percent at the entity level, and each shareholder takes a credit for his or her share. The election is annual and irrevocable once the extended due date for that year passes; an electing company must make quarterly estimated payments if the expected tax exceeds $500. Whether the PTE election helps depends on the owners' federal itemized deductions, which is a question for the tax planning page.

A company can revoke its S election with the consent of shareholders holding more than half of its shares. A revocation made on or before the fifteenth day of the third month of the tax year is effective for that year; a later one takes effect the following year or on a specified later date. Once an election is revoked or terminated, the company generally cannot elect again for five tax years without IRS consent. A corporation that revokes becomes a C corporation, with the 21 percent federal rate, the 9.5 percent Illinois combined rate and a second layer of tax on dividends; an LLC that revokes stays classified as a corporation unless it makes a further classification election, which has its own timing limits. Revocation therefore deserves the same analysis as the original election.

1. Numbers first

   Week one · after you send two years of returns and a current profit-and-loss

   The firm models the election at a reasonable salary and reports in writing whether it saves money after costs.

2. Documents

   Usually week two · only if the election makes sense

   The operating or shareholder agreement is amended for S eligibility and a compensation resolution is prepared.

3. Filing

   Before the deadline · two months and 15 days into the tax year, or with a late-election statement

   Form 2553 is completed, signed by the authorized officer with all owners' consents, and filed by fax with proof of transmission; a late election includes the Rev. Proc. 2013-30 statement.

4. Set-up and calendar

   Usually within a month of filing · the IRS acceptance letter can take longer

   Employer registrations, payroll service hand-off, the IL-1120-ST and PTE decision, and a calendar for the first corporate return.