What is an S Corporation:
Best Service to Form an S Corporation:
What is an S Corporation?
IRS S Corp Definition:
S corporations are corporations, or other entity eligible to be treated as a corporation, that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.
What this means is that corporations and LLCs can "elect" to be taxed as an S corporation and change the way the business would normally be taxed.
For corporations, this means your business can be taxed as a pass-through entity rather than paying double corporate taxes.
For LLCs, this means the business owners can be taxed as employees which can lead to significant savings in self-employment taxes in certain circumstances.
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.
A small business could save on 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
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".
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.
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.
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.
Looking for the right business structure?
Visit our How to Choose a Business Structure guide for help.
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
- New Hampshire
- New Jersey
- New Mexico
- New York
- North Carolina
- North Dakota
- Rhode Island
- South Carolina
- South Dakota
- Washington D.C.
- West Virginia
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.
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.
You will elect S corp on the IRS website as shown here:
Start an S Corp FAQ
What is an S corp?
An S corporation (S corp) is a tax designation for which an LLC or a corporation can apply.
Is an S corp an LLC?
No. An S corp is a tax designation for which an LLC or a corporation can elect.
How do you form an S corp?
You can form an S corp by filing Form 2553 with the Internal Revenue Service (IRS).
What are the requirements for an S corp?
S corps must meet four requirements:
- They can have no more than 100 shareholders.
- All shareholders must be private individuals (not other business entities).
- Shareholders cannot be nonresident aliens.
- The business may only issue one class of stock — this means all members must have the same distribution amount.
What are the benefits of an S corp?
Owners of S corps are considered employees of their company and they can save thousands of dollars on self-employment taxes as a result.
Are taxes for LLCs and S corps the same?
No. The default taxes for an LLC and taxes for an S corp are not the same.
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.
What is a reasonable salary for an S corp?
Unlike the default LLC business structure, in which owners must pay self-employment tax on all of the company’s profits, owners of S corps are considered employees of the business and only have to pay self-employment tax on a salary they receive. Any other money they take from the company’s profits in the form of disbursements isn’t subject to self-employment tax.
S corp owners are required to earn a “reasonable” salary, which basically means a fair market rate based on the individual’s qualifications as well as their duties and responsibilities at the company. The purpose of this requirement is to prevent S corp owners from paying themselves an artificially low salary in order to pay less self-employment tax.
What is a distribution?
A distribution is a dividend that a shareholder/owner can take from the business profits that remain after a company pays all of its employee salaries. Shareholders must pay personal income tax on distributions, but distributions aren’t subject to self-employment tax.
What is pass-through taxation?
Pass-through taxation is a system of taxation that generally applies to sole proprietorships, partnerships, LLCs, and S corps. In this system, the profits or losses of the business are not taxed at the business level. Instead, they pass through to the owners’ personal tax returns and are taxed at each owners’ personal income tax rate.
What is the S corp tax rate?
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.
Can I still use my DBA name if I elect to be an S corp?
LLCs and corporations that operate under a doing business as (DBA) name can choose the S corp election.
How do I pay myself from my LLC?
How LLC owners pay themselves depends on how the LLC is taxed, the number of members, and any agreements regarding profit sharing and sweat equity.
In a single-member LLC (SMLLC) or multi-member LLC (MMLLC), you can pay yourself:
- a distribution that passes through to your individual tax return, or
- a reasonable salary and distribution as an S corp
Read our guide to learn more about how to pay yourself from an LLC article.
What is the difference between an S corp and C corp?
C corporations (C corps) and S corporations (S corps) are two different types of tax statuses. S corps and C corps are often misunderstood to be business structures.
An S corp allows business owners to be taxed as an employee of the business and can reduce your tax burden under the right circumstances.
Businesses taxed as a C corp face double taxation but sometimes the benefits can outweigh the disadvantage of double taxation.
Learn more in our S corp vs C corp guide.