S Corporation Tax Advantages

The S corporation tax status (also called S subchapter), is an IRS tax designation that allows business owners to elect to be taxed as employees of the company. This could lead to tax savings in the right circumstances.

S Corp Tax Benefit: Instead of paying self-employment tax and income tax on all distributions from the business, an S corp owner pays only FICA and income taxes on their salary and only income taxes on distributions.

When Should A Business Elect S Corp Status?

A small business could save in taxes by electing the S corp tax status if the following factors are met:

  • The business meets S corp restrictions
  • The business earns enough in net profit to pay a "reasonable salary" and at least $10,000 in distributions annually
  • The addition of payroll and accounting costs doesn't outweigh tax advantages

diagram showing the requirements of an s corp

S Corp Restrictions

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

Net Profit, Reasonable Salary, and Distributions

To benefit from electing S corp tax status, a business must have enough profit left over (net profit) after running and growing the business to pay the owner(s):

  • a reasonable salary
  • at least $10,000 in distributions.

Under the S corp tax election, business owners are treated as employees for tax purposes. The IRS requires owner-employees to be paid a "reasonable salary".

A reasonable salary is any salary that you would pay someone to do the same job. Websites like Glassdoor or the US Bureau of Labor Statistics are a good place to start researching.

Businesses taxed as S corps are subject to increased scrutiny by the IRS. It is important that your duties and salary match.

In addition to a reasonable salary, we estimate that distributions need to be at least $10,000 annually to create tax savings for business owners.

Payroll and Accounting Costs

Maintaining accounting and payroll for an S corporation is best left to a professional. Payroll and accounting for a small business electing S corp is a yearly expense that must be weighed against tax savings.

How to Start an S Corp

There are two main ways to start an S corp:

  • By forming an LLC and electing S corp tax status from the IRS when you request your employee identification number (EIN)
  • By forming a corporation and electing S corp status from the IRS

We recommend not starting a corporation with the S corp tax status because the S corp negates all of the benefits of a corporation.

Recommended: If you have an existing LLC, visit our How to Convert an LLC to S Corp guide.

Steps to Forming an LLC and Electing S Corp Status

Starting an LLC and electing S corp tax status is easy. You can use our guides to start an LLC with the S corp status yourself, or you can hire a service provider like ZenBusiness to do it for you.

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

Texas        Pennsylvania

Florida      North Carolina

California  Michigan

Ohio         Illinois

New York  Georgia

Step 2: Name Your LLC

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 LLC registered agent will accept legal documents and tax notices on your LLC'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. This is the form to elect S corp tax status for your LLC.