A limited liability company with more than one member is treated by default as a partnership for tax purposes. However, the LLC could elect to be treated as a corporation or S Corporation for tax purposes.
A reason that people consider the S Corporation tax election is that it reduces the social security and medicare taxes that the owner-employees of the LLC will pay.
While electing S corporation tax status for a newly formed LLC can be simple, by filing IRS Form 2553 within 75 days of formation (the instructions state two months and 15 days), there are potential issues with the election.
Among the issues is that most operating agreements are prepared for partnership tax treatment. This is an issue because the terms of such operating agreements run afoul of the S Corporation rules that there is only one class of stock (or membership interests, in the case of an LLC). This means that the membership interests must have identical distribution and liquidation provisions; although voting rights do not have to be identical. Another potential issue is that the LLC cannot have more than 100 members, and there are restrictions on who can be a member: (a) other companies or corporations cannot be members, and (b) no nonresident alien can be a member.
If you make your S Corporation tax election, but your operating agreement or other documents violate a test for S Corporation eligibility, then your election is void and depending on how you the tax election was made, the LLC most likely will be taxed a C Corporation.
If you have any questions concerning this topic, please feel free to contact us.