LLC and S corporation: what each one does in Alabama

People ask us to choose between an LLC and an S corporation more often than they ask anything else, and the question cannot be answered as put, because the two are not alternatives.

An LLC is a legal entity you form with the state. An S corporation is a federal tax election you make with the IRS. Different authorities, different questions, and a great many businesses are both at once.

What forming an LLC does

In Alabama you reserve the name first. That is a separate $25 filing, and the reservation certificate has to be attached to the Certificate of Formation you then file with the Secretary of State. The filing costs $200 to the state plus $100 to the treasurer of the county where your registered agent sits, so the real number is $300. Most guides quote only the $200.

You must also designate and continuously maintain a registered agent, with a registered office at a physical Alabama street address where process can be served in person. No PO box, no mailbox service, no answering service, and the agent has to keep a business office at that same address.

What all this buys is legal separation. The entity holds the contracts and the liabilities rather than you personally. What it does not buy is any particular tax treatment. By default a single-member LLC is disregarded for federal purposes and a multi-member LLC is taxed as a partnership. The LLC itself says nothing about tax.

What the S election does

The election is made on Form 2553 and changes how the business is taxed federally. Profits pass through to the owners' personal returns rather than being taxed at the entity level, and an owner who works in the business becomes an employee, taking a salary through payroll with the remaining profit distributed separately.

That split is the appeal. Payroll wages carry employment tax and distributions generally do not, which is why the condition attached to it is not negotiable. The salary has to be reasonable compensation for the work actually done.

There is no safe harbor and no percentage rule. The 60/40 split you may have heard quoted exists in folklore and in no IRS guidance. What the IRS weighs is a list of factors: your training and experience, your duties, the hours you put in, what you pay non-shareholder staff, what comparable businesses pay for the same work, your dividend history. Underneath all of it sits one principle, which is how much of the company's revenue your personal services generate as against its capital and equipment. That is why a capital-intensive business can defensibly pay a lower salary relative to distributions than a pure services firm can.

The timing rule gets misquoted constantly. The election is due no more than two months and fifteen days after the start of the tax year it applies to, which for a calendar-year business means March 15. It is not "75 days". Miss it and there is relief under Revenue Procedure 2013-30 for an election made within three years and 75 days of the intended effective date, provided the only thing that went wrong was the filing, there was reasonable cause, and everyone reported consistently with S status. Less well known is that the same procedure reaches beyond that window where the corporation has been filing Forms 1120-S all along and the IRS has never raised a question.

The four combinations that exist

An LLC on default taxation is the simplest. Profit flows to your personal return, you pay self-employment tax on it, and there is no payroll to run.

An LLC that has made the S election is the common shape for owner-operated businesses past a certain size. Legal separation from the LLC, the salary and distribution split from the election, and payroll obligations you did not have before.

A corporation taxed as a C corporation pays tax at the entity level and again on dividends at the shareholder level. Right in specific situations, wrong as a default for a small owner-managed business.

A corporation with an S election is the traditional route. On tax it works much like the second option, with corporate formalities in place of LLC ones.

When the election earns its keep

The S election starts paying for itself once profit sits comfortably above a reasonable salary for your role. Below that there is nothing meaningful to distribute and you have bought obligations for nothing. That salary also sets the ceiling on what an owner can put into a Solo 401(k), which is why the two decisions are worth taking together.

Those obligations are recurring. You run payroll, file the returns and make the deposits on time, and missing a deposit deadline carries its own penalty regime. You file a separate business return, Form 1120-S, due March 15 with an extension to September 15, a month ahead of your personal return. Alabama's Form 20S runs on the same dates and the federal extension carries over automatically, though any tax owed is still due on the original date. Preparing both returns is part of our tax services. You document reasonable compensation rather than picking a number once. And you track basis, which matters more than people expect the first time there are losses or distributions above basis.

Somewhere below a certain profit level the annual cost of the election exceeds what it saves. Where that line falls depends on your compensation, your state obligations and how much administrative help you are buying, which is why it is a calculation rather than a rule of thumb. Our S corporation tax estimate calculator gives a first estimate from your own figures.

What Alabama asks, and what it stopped asking

This part has changed substantially since 2023, and most of what is published online has not caught up.

Start with the business privilege tax, because the news is good. Alabama used to charge a $100 minimum. Act 2022-252 cut it to $50 for 2023 and then, for tax years beginning after December 31, 2023, exempted those taxpayers from the tax and from the filing requirement itself. If your calculated privilege tax comes to $100 or less, you do not file a return at all.

Two things to watch. It is a cliff rather than a deduction, so a calculated $101 means filing and paying the full $101. And the calculation looks backwards, using the prior year's balance sheet, so a business that grew last year can cross the line this year without anything changing in this one.

The Secretary of State's corporation annual report is gone too. When the privilege tax exemption landed it accidentally separated the annual report from the tax return it used to ride along with, leaving corporations filing a standalone $10 form for most of 2024. That was repealed outright with effect from October 1, 2024. No Alabama entity files one now.

Put those together and an Alabama LLC or corporation whose privilege tax works out at $100 or less files nothing annually with either the Secretary of State or the Department of Revenue. If somebody is still charging you to prepare those filings, ask what they are preparing.

The part nearly every guide still gets wrong

Search for what happens if you lose your registered agent in Alabama and you will be told the state administratively dissolves you after 60 days. That was true once. The provision was repealed with effect from January 1, 2020 and nothing replaced it.

The statute that sounds like the successor is not one. Section 10A-1-5.35 is titled "failure to designate and maintain registered agent", but what it actually does is make you servable by substituted service under the Alabama Rules of Civil Procedure. It says nothing about dissolution. For an LLC, the events that cause dissolution are an event stated in the operating agreement, unanimous member consent, having no members left, or a court order. There is no administrative ground on the list.

That reads like good news and largely is not. Because nothing dissolves you automatically, a dormant Alabama entity does not quietly lapse. It stays on the register. The Department of Revenue states the consequence plainly: the business privilege tax remains due every registered year until the entity is legally dissolved or withdrawn through the Secretary of State, whether or not it is carrying on any business. An old LLC you stopped using two years ago is still your LLC, and the obligation is still yours.

The practical upshot of losing your agent is worse than dissolution in one specific way. You do not get struck off and told about it. You become quietly easier to serve, which is how default judgments happen.

Licenses, in up to three layers

A state and county business privilege license, taken out with the probate judge or license commissioner in each county you operate in. A county license in some places. And a municipal license on top.

The state and county license year runs October 1 to September 30, goes delinquent on November 1, and carries a 15% penalty plus interest after that. Birmingham runs on the calendar year instead: due January 1, delinquent February 15. A Birmingham business therefore has two unrelated license deadlines four months apart, which is how one of them gets missed. Jefferson County put state and county renewals online in October 2025, which helps.

Separate again is the annual renewal of your Alabama tax account license if you hold one for sales, rental, sellers use, lodgings or utility gross receipts. That is done in My Alabama Taxes between November 1 and December 31. Different license, different system, different window.

None of these change based on the S election. Alabama follows the federal election automatically, so there is no separate state election to make and none to forget. The election does not change any of these license obligations.

The mistake worth avoiding

The usual failure is making the election because somebody described the tax saving at a conference, with nobody running the payroll cost, the reasonable compensation figure and the state obligations against it. Making the election is straightforward. Unwinding it is not. If you want the numbers run before you decide, that is advisory work we do for business owners.

Run the numbers first. It is an afternoon's work and it settles the question for several years.

Common questions

Can my LLC be an S corporation?

Yes, and it is the most common structure we see for owner-operated businesses. You keep the LLC as the legal entity and elect S treatment for tax. Nothing about the LLC has to change.

Will the S election lower my taxes?

It can reduce employment tax on the profit taken as distributions rather than salary. Whether that exceeds the cost of payroll, an extra return and the compliance work depends entirely on your numbers, and below a certain profit level it does not.

What counts as reasonable compensation?

What you would have to pay somebody else to do your job, in your market, for your hours. It is fact-dependent, there is no percentage safe harbor, and it should be documented at the time rather than reconstructed afterwards.

Do I still owe Alabama business privilege tax as an S corporation?

Possibly not. Since 2024, entities whose calculated privilege tax is $100 or less owe nothing and file nothing. That turns on the size of the entity rather than on the S election. An LLC files Form PPT either way, so the election does not change its form; a C corporation that elects S status moves from Form CPT to Form PPT.

I formed an LLC online years ago and never thought about tax. Is that a problem?

Not necessarily. You have default treatment, which suits plenty of businesses. It is worth a look if profit has grown since you formed it, or if you are about to take on partners or employees. Check your registered agent is still current while you are in there.

Should I make the Alabama pass-through entity election?

It is a separate decision from the S election and often a worthwhile one. Alabama's deadline is unusually generous, running as late as the extended due date of the return, but it needs a vote of the governing body and of owners holding more than half the voting control, and the box has to be ticked on the return every year it applies. A missed tick ends it quietly.