How to Start an S Corp as a Contractor

An S corporation (S corp) is an Internal Revenue Service (IRS) tax classification that may help your contractor business save money on its taxes. Contractors assist with construction efforts for large projects. Some even manage projects as general contractors, overseeing the work to ensure it’s done correctly. 

No matter how long you’ve run your contractor business, you could potentially save thousands of dollars each year by electing S corp status.

Recommended: Save yourself the hassle and use a professional service like ZenBusiness to help you handle the initial S corp election paperwork.

What Is an S Corporation?

An S corporation (S corp), also known as Subchapter S, is a tax status with strict IRS requirements and restrictions. If your business meets the requirements to be taxed as an S corporation, you will be eligible for certain tax benefits such as pass-through taxation and self-employment tax savings, which can be significant. 

Essentially, an S corporation provides the perfect opportunity for business owners to have both the benefits of a default LLC with pass-through taxation and some of the perks of a C corporation without the dreaded double taxation.

S Corp Requirements

In order to be taxed as an S corporation, your contractor business must meet the following requirements:

• Has 100 shareholders or less
• Is a domestic LLC or corporation
• Issues only one class of stock
• Shareholders are US citizens or permanent resident aliens
• Is owned by private individuals

What Type of Business Structures Can Start an S Corp?

An S corp designation can be elected by a formal business structure, specifically an LLC or a corporation. Informal business structures such as sole proprietorships and partnerships are not eligible for the S corporation classification. 

Don’t have a formal business structure? If your contractor business isn’t currently an LLC or C corporation, our friends at ZenBusiness can form your legal business entity for you and elect S corp tax status in no time.

S Corp Tax Benefits a Contractor Should Know

S corporations enjoy certain tax benefits, such as pass-through taxation (all losses and profit — credits, distributions, deductions — pass directly to the owner). This is similar to how default LLCs are taxed. With pass-through taxation all profits bypass the company and go directly to the owners, and owners pay on their personal tax return at their regular income tax rate.

Default LLC Taxes Explained

Business owners of default LLCs pay self-employment taxes and income tax on the distributions passed down to them. In other words, both types of taxes are imposed on all the money they receive after paying business expenses. Self-employment taxes include social security and medicare, and these two taxes.

S Corp Taxes Simplified

With an S corporation, owners are classified as employees and are paid in two ways: a salary and distributions.

Reasonable Salary

Since owners are employees, they must receive a salary, and therefore they must run payroll. Business owners pay self-employment taxes and income tax on their salaries. The IRS must consider your salary as “reasonable” — the equivalent of what someone else doing the same job would earn. Determining your reasonable salary will require some research, but online resources like Glassdoor and the US Bureau of Labor Statistics can help you find averages and pay scales for your profession.

The average salary of a contractor in the United States is $51,734. This can vary, however, based on your location, experience, and role. For example, a general contractor’s average salary is $63,341 per year. Remember to consider these variables in your research in order to pick the right salary for you and your business.

Distributions

Unlike with the reasonable salary, the owner only pays income tax on the distributions. This means the business owner does not pay the self-employment tax of 15.3% on money taken as a distribution.

When Should a Contractor Elect S Corp Status for a Business?

This is a subjective question and will depend on your business and your goals. You need to be sure to take enough money in distributions to benefit from the advantages offered by an S corporation and offset the additional paperwork and fee associated with running payroll. In general, you will likely benefit from S corp status once your business makes at least $60,000 in earnings and $20,000 in annual distributions. These numbers are after paying business expenses. The IRS requires S corp owners to pay themselves a reasonable salary to ensure they aren’t lowering their compensation to avoid paying more on taxes — which would lead to loss of S corp status, fines, and even business dissolution.

Use our S Corp Tax Calculator to find out if an S corp is right for your business. Calculate your savings below:

Six Basic Steps to Start 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

Step 1: Select Your State

• Alabama
• Alaska
• Arizona
• Arkansas
• California
• Colorado
• Connecticut
• Delaware
• Florida
• Georgia
• Hawaii
• Idaho
• Illinois
• Indiana
• Iowa
• Kansas
• Kentucky
• Louisiana
• Maine
• Maryland
• Massachusetts
• Michigan
• Minnesota
• Mississippi
• Missouri
• Montana
• Nebraska
• Nevada
• New Hampshire
• New Jersey
• New Mexico
• New York
• North Carolina
• North Dakota
• Ohio
• Oklahoma
• Oregon
• Pennsylvania
• Rhode Island
• South Carolina
• South Dakota
• Tennessee
• Texas
• Utah
• Vermont
• Virginia
• Washington
• Washington D.C.
• West Virginia
• Wisconsin
• Wyoming

Step 2: Name Your LLC

If you don’t already have a business, you will first need to form one. You will need to provide your state with a unique name that is distinguishable from all registered names when you file your LLCs formation documents.

Our Business Name Generator and our How to Name a Business guide are free tools available to entrepreneurs that need help naming their business.

Step 3: Choose an LLC Registered Agent

Your S corp registered agent will accept legal documents and tax notices on your business's behalf. You will list your registered agent when you file your LLC's Articles of Organization.

Step 4: File Your LLC's 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.

Step 5: Create an LLC Operating Agreement

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.

Step 6: Get an EIN and Complete Form 2553 on the IRS Website

An EIN is a number that is used by the US Internal Revenue Service (IRS) to identify and tax businesses. It is essentially a Social Security number for a business. 

EINs are free when you apply directly with the IRS.

Elect S Corp Tax Status

During the online EIN application, the IRS will provide a link to Form 2553, the Election By a Small Business form.

Steps to Take After Starting an S Corp

Once you formalize your S corp, be sure to get your financials in line so you are ready to begin operating.

For business banking, check out our guide on the best banks for small businesses.

If you need to build your S corp credit, read our guide on how to build business credit and get a business credit card through Divvy.

Contractor Business Information

Contractors work on construction projects, often performing a specific task in which they’re proficient like plumbing or electrical work. General contractors usually oversee projects and hire other contractors to fill roles not covered by their current staff and to accelerate the construction process. 

Given the widespread demand for construction, contractors can find work in just about every location nationwide. Estimates show nearly 470,000 contractor businesses currently operate within the United States.

Why Most Contractor Businesses Should Have a Legal Business Entity

Liability protection is the top reason you should register your contractor business as a legal business entity. If a third party tries to sue your business, having a legal business structure will protect you and your employees.

Imagine you’re a general contractor, for example, and you hire an electrician to work on a building project you’re overseeing. A week into operation, a fuse box catches fire and causes significant damage to the property. The owners want to sue you over this. Because your business has a formal business structure, they can’t sue you as an individual — only your business. That means your business’s assets will be at risk in a settlement and not your personal assets.

Is an S Corp Right for My Contractor Business?

Your business’s long-term goals will help you determine if it makes sense to elect S corp status. You’ll also need to consider if you and your business meet the IRS’s requirements for S corps.

For example, do you currently run payroll for your business? The IRS requires S corps to run payroll for all of their employees, including their owners. This likely won’t be an issue for businesses with multiple employees that already run payroll. But, it may be a deal breaker for those with only one employee or that can’t afford to pay a payroll service.

The IRS also mandates that S corps can have no more than 100 shareholders. Larger companies and those with diversified income sources may have a harder time with this requirement than smaller businesses or those operating for just a short time. If staying below this limit seems difficult, you may want to consider having the IRS tax your business as a C corp instead.

Lastly, the IRS requires all S corp owners to take a distribution from their business’s net profits. In order to fully benefit from an S corp’s tax advantages, you’ll need to take at least $10,000. If you’d rather reinvest that money in your business, having the IRS tax it as an LLC may provide a better fit right now.

Only you, as the owner, can decide if electing S corp status will benefit your business. Carefully consider all of the requirements and do your research before you file the paperwork.

Contractor S Corporation Examples

Not all contractors will benefit from the S corp tax designation. Here are two examples to help illustrate which types of contractors should consider electing S corp status.

Scenario 1:

Imagine you’re a general contractor who works in a larger city. After operating there for several years, many of your former clients refer others to your business. This positive reputation has made you and your business one of the most sought-after general contractors in the area. 

You’ve run payroll for your employees for years, and you’ve become quite close with your group of 30 shareholders. Because you have consistent work and make more than enough to pay your employees and make ends meet, you’re content with the current state of your business. 

This business is a good candidate to file for S corp status. Because you don’t plan to expand your pool of shareholders and you already run payroll, you’d only need to establish your reasonable salary and take a distribution.

Scenario 2:

Now, imagine you’re an independent contractor who specializes in plumbing. You work out of your garage and use your personal vehicle to get to jobs. There are lots of big construction projects in your area, and you have good relationships with many of the general contractors. 

You’re set to work on eight different projects for high-paying businesses this year so you may be able to afford to make some upgrades to your business. Specifically, you want to buy a new truck for work that can carry all of your equipment and limit the miles on your personal vehicle. 

Electing S corp status likely won’t benefit a business like this. While you’d fall under the 100-shareholder maximum, the cost of running payroll and taking a distribution would divert money away from your reinvestment goals.

Start an S Corp FAQ