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
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.”
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.
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.
S Corp Status for LLCs and Corporations
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
Self Employment Tax:
Salary Employer Tax
(S Corp pays)
Savings on Self Employment Taxes
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.
Hire a professional service provider like Collective for all your S corporation needs, including:
- S corp formation or to convert an existing business
- Registered agent services and obtaining an EIN
- Managing your monthly accounting (payroll, bookkeeping)
- Personalized service with a back office team
- Keeping your business compliant with regulatory obligations
- Helping you find potential business tax savings, and more.
Connect with Collective to learn more!
How to Start an S Corp
Use our state-specific guides below to learn how to start an S corp 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
Step 1: Name Your LLC
To choose a name for your LLC, perform a business name search online to make sure the name hasn’t been taken and meets your state’s naming requirements. Check out our How to Name a Business guide for more information about naming your business.
Step 2: Choose a Registered Agent
A registered agent is a person or entity that you designate to receive legal papers and other official documents on behalf of your company. In particular, a registered agent is crucial for receiving service of process if your company is sued.
In most states, you need to name a registered agent when you form your LLC. This person or entity must have a physical address in the state or be authorized to conduct business there.
Our What Is a Registered Agent guide has more information about choosing a registered agent. Although anyone technically can serve as a registered agent, we recommend using a registered agent service that has experience and expertise in this area.
Step 3: File Your LLC’s Articles of Organization
The Articles of Organization, sometimes known as a Certificate of Formation or Certificate of Organization, consists of documents required by the state for your LLC to operate. These must be filed with the state’s business division, usually the Secretary of State.
An LLC formation service can help you file these documents, or you can file them yourself. Filing fees are about $100 to start an LLC.
Step 4: Create an LLC Operating Agreement
An LLC operating agreement describes how your LLC is structured and what the members’ responsibilities are. An operating agreement isn’t required in most states, but it is recommended so that members understand how the LLC will run and what is expected of them.
For more information, read our What Is an LLC Operating Agreement article.
Step 5: Get an EIN
An Employee Identification Number (EIN) is a number the IRS uses to identify a business for tax purposes. This is required for your LLC to hire anyone or open a business bank account.
An EIN is similar to a Social Security number for individuals and can be obtained for free on the IRS website, by fax, or by regular mail. For a more in-depth look at EINs, check out our What Is an EIN article.
Elect S Corp on Your EIN Form
Once you’ve formed your LLC, starting an S corp is as simple as filing Form 2553 if your LLC meets the ownership qualifications for S corp status. These qualifications include:
- The LLC has no more than 100 members.
- All members are US citizens or permanent residents.
- The LLC is not owned by any other business entities.
If you file for S corp status before March 15, the IRS will tax your LLC as an S corp for the current tax year. For help with completing this step, visit our guide to filing IRS Form 2553.
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.