What Is S Corp Tax Status?
An S corp isn’t a business structure like an LLC, partnership, or C corp. Rather, an S corp is a tax status that a company requests from the IRS.
An S corp has several advantages, including potentially lower taxes.
However, not every LLC will save money by electing the S corp tax classification. In addition, an LLC has to meet certain criteria to make the election.
In this section, we discuss:
- The differences between an LLC and an S corp
- Why you might elect S corp tax status for your business
- Why an LLC is best for S corp tax status
LLC vs. S Corp
An LLC is a type of business structure. By contrast, an S corp is an IRS tax status that an LLC or a corporation can elect.
If an LLC doesn’t elect to be taxed as an S corp, it files taxes under the “default LLC” classification. Most small businesses choose to be taxed as “default” LLCs because they:
- Don’t have enough net profits to reap an S corp’s tax advantages.
- Don’t know what their net profits will be in a given year.
- Want to reinvest most of their profits in the business rather than distribute them to owners.
Why Might You Elect S Corp Status for Your LLC?
An LLC owner might want to elect S corp status to save money on self-employment Federal Insurance Contributions Act (FICA) taxes. That’s because, unlike an LLC owner, an S corp owner is considered an employee of the company.
As a result, an S corp owner pays FICA taxes on their reasonable salary from the company, but not on the rest of their share of the company’s profits. These are distributed as dividends, which are subject to income tax but not FICA taxes.
The bottom line is that S corp owner(s) can save about 17% in taxes if the following statements are true:
- The business can pay the owner(s) a "reasonable salary" every year.
- There are substantial distributions year over year (about $10,000).
- There is a positive return on investment for payroll service and accounting costs associated with running an S corp.
- The business meets S corp requirements.
A reasonable salary is one that is typical for an S corp’s owner in the industry. Thus, what counts as “reasonable” will vary based on the type of business.
However, note that there are a few disadvantages of S corps. These include closer scrutiny from the IRS, which will look to see if the company is actually paying its owners reasonable salaries; greater complexity, which could lead to filing mistakes; and a limit of 100 shareholders.
Why an LLC Is Best for S Corp Tax Status
It makes sense to form an LLC rather than a C corp if you plan to elect S corp status. That’s because a C corp has its own set of advantages that will be negated by an S corp designation.
How to Elect S Corp Status for an LLC
Before electing S corp status for your LLC, you first have to determine whether your company qualifies to do so according to the IRS. In addition, you have to decide whether it makes sense for your business to elect S corp status or remain an LLC. Below, we explain:
Qualifications for Electing S Corp Status
Not just any LLC can elect to be taxed as an S corp. Rather, the LLC must:
- Have no more than 100 shareholders.
- Issue only one class of stock.
- Be owned by individuals who are US citizens or permanent residents.
- Not be owned by business entities like LLCs, corporations, or trusts.
If your LLC meets these criteria, it may elect S corp status. However, read on to see when it makes sense to do so.
When to Elect S Corp Status
An LLC will only benefit from S corp status if it has enough net profits to pay its owners a “reasonable salary” and at least $10,000 in annual distributions. Moreover, the tax savings from electing S corp must outweigh any additional payroll and accounting costs that come with S corp status.
The reason S corps must pay their owners a reasonable salary is that the owners are considered employees of the S corp for tax purposes. A reasonable salary is any salary that is considered reasonable for the industry and the specific job an owner does.
How to Elect S Corp for a New LLC
A new LLC can elect S corp status from the IRS during formation when it requests an employee identification number (EIN). There are six steps to forming an LLC and elect S corp status:
Step 1: Select a State
Step 2: Name Your LLC
Step 3: Choose a Registered Agent
Step 4: File the Articles of Organization
Step 5: Create an Operating Agreement
Step 6: Get an EIN and File Form 2553 to Elect S Corp Tax Status
Use our state guide for instructions on how to form an LLC in your state.
- New Hampshire
- New Jersey
- New Mexico
- New York
- North Carolina
- North Dakota
- Rhode Island
- South Carolina
- South Dakota
- Washington D.C.
- West Virginia
Every LLC needs a unique name that meets state naming regulations. Our Business Name Generator and our How to Name a Business guide are free tools available to entrepreneurs that need help naming their business.
A registered agent is a person or entity that you designate to receive court papers and other official documents on behalf of your company. The registered agent is listed in your Articles of Organization.
The Articles of Organization, also known as a Certificate of Formation or a Certificate of Organization in some states, is the document you will file to officially register an LLC with the state.
An LLC operating agreement is a legal document that outlines the ownership and member duties of your LLC.
Our operating agreement tool is a free resource for business owners.
An EIN is a number that the IRS uses to identify and tax businesses. It functions the same way a Social Security number does for an individual.
EINs are free when you apply directly with the IRS. When you apply for an EIN, the IRS will provide a link to Form 2553, which you use to elect S corp status.
For more information, see our LLC vs. S Corp guide.
Filing Form 2253
Form 2553 is the IRS Election by a Small Business Corporation form. An LLC or corporation uses Form 2553 to elect S corp tax status.
To file Form 2553, an LLC that is eligible for S corp status needs to:
- Check Form 2553 Due Dates
- Complete and File Form 2553
Check Form 2553 Due Dates
An LLC must file Form 2553:
- No more than two months and 15 days after the beginning of the tax year in which the LLC wants the S corp election to be effective
- Any time in the year before the tax year that the LLC would like the S corp election to be effective
An LLC can elect several different tax years and remain eligible for S corp election. For more information, see the "general" section of the IRS instructions to Form 2553.
Complete and File Form 2553
For instructions on completing and filing Form 2553, as well as where to send it, see our Form 2553 Instructions guide.
S Corp Frequently Asked Questions
Do I need an attorney to form an S corporation?
While it is always good to seek professional legal advice, it is possible to form an S corp without an attorney if you have an LLC.
Where can I find S corp tax return forms?
Subchapter S Form 1120S is available on the IRS website.
Which is better for taxes LLC or S corp
The default LLC tax status is better for small businesses that reinvest profit to grow their business. An S corp is better for businesses that have profit left-over to pay owners a reasonable salary and at least $10,000 in distributions.