Benefits of an S Corp
An S corporation (S corp) is a tax status that can be elected by an LLC or corporation.
LLC owners can save money on taxes by electing S corp status in some circumstances. Corporations can avoid double-taxation by electing S corp status.
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What Is an S Corporation?
An S corp isn’t a business entity in and of itself, like an LLC or corporation. Rather, an S corp is a tax status that a business can elect with the Internal Revenue Service (IRS).
Both corporations and LLCs can choose to be taxed as S corps if they meet certain qualifications. Read our What Is an S Corp guide for more information about these requirements.
Why Choose S Corp: Advantages and Disadvantages
Being taxed as an S corp can have several advantages over being taxed as a standard LLC or corporation.
Advantages of an S Corp
Advantages of choosing S corp status include:
- Tax savings
- Easier transfer of ownership
Tax Savings
The S corp tax status allows a business owner to be treated as an employee of the company. As employees, LLC owners no longer have to pay self-employment taxes on disbursements.
In an LLC that is taxed as an S corp, the LLC's profits are paid to owners in the form of salary and distributions. The IRS then applies FICA and income taxes to only the salary.
Distributions are only subject to income tax. In a standard LLC, the full distribution amount is subject to a 15.3% self-employment tax.
For corporations that elect S corp tax status, the business is only taxed at the individual shareholder level because income passes through to the owner’s individual tax return. As a result, an S corp avoids “double taxation.”
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Easier Transfer of Ownership
An S corp can transfer all of its ownership interests without negative consequences. If an LLC transfers more than half of its ownership interests, the business could be terminated.
Disadvantages of an S Corp
The disadvantages of an S corp include:
- Increased IRS scrutiny
- Additional fees
- Restrictions on stock ownership
Increased IRS scrutiny
If an LLC is taxed as an S corp, it may be subject to more scrutiny from the IRS. In particular, the IRS will look to see if the owner is paid a reasonable salary while possibly assessing fines and back taxes if this is found not to be the case.
Additional Fees
There are minimal filing fees required to elect an S corp. There are substantial bookkeeping and payroll costs that an LLC may not have unless it already employs people.
Restrictions on Stock Ownership
An S corporation can only issue one class of stock. However, because it can have both voting and non-voting shares, this need not be much of a restriction. This is fine for an LLC but might not be very attractive to a corporation.
When to Choose an S Corp
You should elect to be taxed as an S corp if these four things are true:
- You know you’ll want to take money out of your business rather than reinvest profit to grow the business, year over year.
- You know your business will generate enough profit to pay the owner(s) a reasonable salary and at least $20,000 in annual distributions.
- Your business is an LLC or corporation.
- The business meets S corp requirements.
Reasonable Salaries and $20,000 in Distributions
Before electing S corp tax status, you need to know that your business will generate enough profit to pay the owner(s) a reasonable salary and at least $20,000 in annual distributions.
A reasonable salary is a salary that is consistent with the market standard for the work performed.
Business owners that choose S corp status will need to hire payroll and accounting professionals. This cost must be offset by tax savings.
Recommended: Take a look at our Best Payroll Service review and schedule a free accounting consultation to learn more about pricing.
S Corp Status for LLCs and Corporations
Your business must be structured as an LLC or corporation in order to be taxed as an S corporation.
If your business is already an LLC or corporation, you can elect S corp status by completing IRS Form 2553. Visit our How to Elect S Corp Status guide to learn more.
S Corporation Requirements
The IRS requires that businesses that elect the S corp status:
- Have 100 shareholders or less
- Issue only one class of stock
- Have owners that are US citizens or permanent resident aliens
- Are owned by private individuals and not business entities such as LLCs, corporations, or trusts
S Corp Savings Calculator
Calculate how much you can save by choosing an S Corp tax classification
As a Sole Proprietorship or Single-Member LLC
Net Income:
Self Employment Tax:
S Corp
Net Income:
Salary:
Salary Employer Tax
(S Corp pays)
Dividend
Total Employment
Taxes Paid
Savings on Self Employment Taxes
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Against this savings, you have to balance the time and costs of running payroll and tax withholding. To learn more about what this will cost, get a free tax consultation.
How to Start an S Corp
Visit our How to Start an S Corp guide and select your state to get started or work with an affordable S corp formation service.
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S Corporation Frequently Asked Questions
What does S corp mean?
S corp is short for S corporation, which gets its name from the related part of US tax law: subchapter S of chapter one of the IRS code.
What are the pros of an S corporation?
Potential advantages of an S corp include personal liability protection, pass-through taxation, and easy transfer of ownership.
Do S corps pay income tax?
S corps don’t pay a corporate income tax. Instead, owners pay personal income tax on the company’s earnings.