If your LLC has elected to be taxed as an S Corporation, congratulations—you’ve likely positioned your business for significant tax savings. But there’s a critical legal step that many business owners overlook: updating your Operating Agreement to reflect your new tax status.
The Risk No One Talks About
When an LLC elects S Corporation tax status, its Operating Agreement must be amended to:
- Remove default partnership tax language (which no longer applies)
- Prohibit disproportionate distributions (which violate S Corp rules)
- Affirm S Corp shareholder requirements (such as one class of stock and permissible shareholders)
If your Operating Agreement still reflects partnership-based allocations or allows distributions not strictly proportional to ownership, your LLC is not in compliance with S Corporation requirements. This noncompliance can trigger revocation of your S Corp status—an outcome that carries serious tax consequences.
The $38,000 Mistake
If the IRS discovers that your LLC is out of compliance (often during an audit), it may retroactively terminate your S Corp election. The only way to restore your S Corp status is by obtaining a private letter ruling from the IRS, which currently costs $38,000—and that doesn’t include legal or accounting fees to prepare the request.
That’s an extremely expensive fix for a problem that can be prevented with a properly drafted Operating Agreement.
Here’s What You Need to Do
If your LLC:
- Has elected S Corporation status for tax purposes, and
- Has not amended its Operating Agreement since making that election, you need to act now to avoid costly consequences.
At The Kaiser Law Firm, P.C., we regularly review and revise LLC Operating Agreements to ensure they comply with S Corporation requirements. We work with your CPA or tax advisor to make sure your legal structure supports your intended tax treatment—not undermines it.
Protect Your Tax Status—Contact Us Today
Don’t risk losing your S Corp election and facing a five-figure IRS bill. If you’re unsure whether your Operating Agreement is compliant, let us review it for you. Contact us at 314 (966-7766), or schedule a consultation now.