Last Updated: June 10, 2024, 9:37 am by TRUiC Team


How to Start an S Corp as a Software Engineer

An S corporation (S corp) is an Internal Revenue Service (IRS) tax classification that may help your software engineering business save money on its taxes. Software engineers use their coding abilities to design software and troubleshoot bugs that arise in the applications they create. While software engineering can provide a lucrative business opportunity, saving money on taxes is always advantageous for business owners. 

Regardless of your tenure as a software engineer, electing S corp status for your business may help you save thousands of dollars at tax time.

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

Software engineer working on a computer.

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 software engineering 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. 

How to Start an LLC Tip Icon

Don’t have a formal business structure? If your software engineering 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 Software Engineer Should Know About

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. One of the IRS’s criteria for S corps is that the owner(s) must pay themselves a “reasonable” salary. This is equivalent to the salary of someone who does the same work as you — although variables like experience and location can affect what’s reasonable for you and your business. To get an accurate average or salary range for the work you perform, check out online resources like Glassdoor and the US Bureau of Labor Statistics.

According to Glassdoor, the average salary of a software engineer is $106,672. Senior software engineers with more experience earn a bit more, averaging $148,249 per year. Location also plays a role, with those employed in larger cities and metropolitan areas making more due to the overall higher cost of living when compared to rural areas. Remember to factor this in when doing your research.

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 Software Engineer 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:

S Corp Savings Calculator

Calculate how much you can save by choosing an S Corp tax classification

Recommended:

Are you a solopreneur looking to start your S corp or convert your existing LLC and start saving on taxes? Get your S corp started today with ZenBusiness.

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

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.

Recommended: You’ve worked hard and deserve a break! If you make at least $20,000 in distributions, let ZenBusiness start your S corp, so you can focus on your business.

Software Engineering Business Information

Software engineers build and protect software programs used by companies and the general public. Companies often hire them to assist in the creation of apps, computer programs, and other software and to troubleshoot any issues that arise. In some cases, a company may bring them into an ongoing project to finish the code and get things up and running. 

While software engineers can work anywhere, most work near large cities or technology hubs like California’s Silicon Valley or Denver — an increasingly popular place for tech startups. An estimated 4.4 million software engineers work in the United States alone.

Why Most Software Engineering Businesses Should Have a Legal Business Entity

The most important reason to register your software engineering company as a legal business entity is to give yourself and your employees' liability protection in the event someone takes legal action against your business. If a software program you helped troubleshoot still has an issue and hackers exploit this to steal the personal information of hundreds of clients’ customers, for example, the client may sue you. The limited liability that comes with a formal business structure will protect your personal assets because a third party can only sue your business – not you as an individual.

Legal business entities also enjoy greater legitimacy and professionalism. Clients are more likely to trust and work with you if they know your company has a formal business structure.

Is an S Corp Right for My Software Engineering Business?

When considering if your business should elect S corp status, think about your long-term business goals. The IRS requires S corps to run payroll for all of their employees. While this likely won’t concern businesses that have lots of employees or already pay for accounting services, the cost of running payroll can present an obstacle for smaller businesses looking to save money. If you’re a solo software engineer, the money you’d save on taxes as an S corp may not exceed what you’ll have to pay to run payroll for just you.

You also need to think about if you want to take on investors or find additional funding sources. S corps can have no more than 100 shareholders, so your software engineering business may work better as a C corp if you plan to take on a large number of investors.

Finally, you also should consider whether you want to reinvest money back into your business or take more of your business’s profits out for yourself. If you’d prefer to use those profits to buy new equipment or upgrade your facilities, then it’s likely not the right time to elect S corp status. Why? In addition to paying themselves a reasonable salary, S corp owners must take a distribution from their business’s profits. You’ll need to take at least $10,000 in distributions in order to fully benefit from the tax advantages of an S corp. If you’d rather put that money back into your business, it may work better as an LLC.

Software Engineer S Corporation Examples

Some software engineering businesses will benefit from electing S corp status while others won’t. To help you decide if the S corp tax designation is right for you, compare the following examples to your business’s circumstances.

Scenario 1:

Let’s say you run a software engineering startup. Through networking, you and five other software engineers in your city work together in a cooperative workspace you rent and share with another business. Two notable corporations with offices in the area just hired you to perform troubleshooting for several web developers across the country that’ll use you to test the current builds of mobile phone apps. Because business is good and your employees plan to stay with your company for a few years, you’re looking into starting to run payroll. 

In this case, electing S corp status likely would benefit your business. Because you already plan to start running payroll, you’d just need to ensure you don’t exceed 100 shareholders and that you take a distribution on top of your reasonable salary.

Scenario 2:

Now, imagine you’re a solo software engineer who works from home. You have no need to run payroll because it’s only you. In the last two years, you’ve built a good relationship with your clients — local businesses and small independent development teams around the country. Many of your clients want to invest in your work, so you’re seriously considering expanding. However, you need some new equipment and would like to move into an office. 

Electing S corp status probably won’t prove advantageous for your business in this situation. The cost of running payroll would severely reduce your tax savings, and the required distribution would divert funds away from your goal of reinvesting in your business. Moreover, you may exceed the S corp limit of 100 shareholders if multiple people want to invest in your company.

Start an S Corp FAQ

An S corporation (S corp) is a tax classification that an LLC or a corporation can apply for that provides self-employment tax savings on distributions.

If you already have an LLC or C corporation, you can form an S corp by filing Form 2553 with the Internal Revenue Service (IRS).

S corps offer businesses tax advantages, and owners of S corps can save thousands of dollars on self-employment taxes.

While both LLCs and S corps benefit from pass-through taxation, they are not taxed the same way.

With an S corp, owners pay personal income tax and self-employment tax on a predetermined salary. They may then withdraw any remaining profits from the business as a “distribution,” which isn’t subject to self-employment tax. With an LLC, all company profits pass through to the owners’ personal tax returns, and then the owners must pay personal income tax and self-employment tax on the entire amount.

Both LLCs and S corps benefit from a provision in the Tax Cuts and Jobs Act of 2017 that allows qualifying owners of pass-through entities to deduct 20% of qualified business income (QBI) from their tax returns. However, for S corps, the deduction doesn’t apply to profits paid out as wages.

The average salary of a software engineer in the United States is $106,672, according to Glassdoor. This can vary, though, depending on an individual’s experience and location. Remember to factor that in when deciding on your reasonable salary.

A distribution is a dividend that a shareholder/owner can take from the business profits that remain after a company pays all of its employees' salaries. Shareholders must pay personal income tax on distributions, but distributions aren’t subject to self-employment tax.

There’s no corporate tax rate for S corps. Instead, owners of S corps pay personal income tax on the company’s profits. This rate depends on each owner’s personal income tax bracket. 

In some states like California and New York, S corps may pay some form of tax at the corporate level.

While you can use your distribution for whatever you want, it must be sent to your personal bank account. You can’t route it to another person or business, and you can’t use it until it successfully transfers into your personal account.

No. While most of the S corp criteria set by the IRS apply to LLCs, other business types like C corps can elect S corp status as long as they meet those requirements.