S Corp Taxes

The S corporation (S Corp) is a tax status that you can elect with the Internal Revenue Service (IRS).

Under the right circumstances, S corp tax status allows business owners to pay fewer taxes on their earnings.

Continue reading our S Corp Tax guide to learn more about when to choose the S corp tax status, how S corp taxes work, and how to elect S corp status.

Have S corp tax questions? Call (801) 790-0473 or schedule a meeting here.

S Corporations Simplified

If you’re searching for the right business structure for your company, there are many factors to consider. The most important one is understanding the different types of formal and informal business entities available. Included among options you’ll have to choose from are informal business structures — sole proprietorship or a partnership — and legal, formal business structures — limited liability company (LLC) or a corporation. 

An S corporation (S corp) is a tax classification one can choose instead of a C corporation. An S corp is taxed differently, has specific requirements, and can be elected by either an LLC or a corporation. We will cover everything you need to know about S corp taxes, so you can decide what’s best for your business.

Key Takeaways:

• An S corporation, known as subchapter S under the IRS code, is a tax designation and not a legal business entity.
• There are specific IRS requirement an S corp must have 
• S corps in most states do not pay corporate taxes
• Pass-through taxation allows business income, losses, deductions, and credits to pass directly to shareholders
• Owners or Shareholders report income and losses on individual tax returns at their personal tax rate
• S corporations have a maximum of 100 shareholders who must be U.S. citizens or permanent resident aliens
• An S corporation must be based in the United States.

What Is an S Corporation?

An S corporation is a tax status of the Internal Revenue Code (IRS) Subchapter S elected by LLC or corporation business owners by filing Form 2553. Electing S corp status allows a business to have pass-through taxation as in a sole proprietorship, partnership, and LLC. An S corp also has some benefits offered to corporations without the double taxation. For tax purposes, a subchapter S allows business losses, deductions, and credits to pass down to shareholders. As such, shareholders can pay taxes on their personal income tax returns.

Why Would You Choose an S Corporation?

Under the right circumstances, S corp tax status allows business owners to pay fewer taxes on their earnings.

You should elect to be taxed as an S corp if these four things are true:

• You know you’ll want to take a substantial portion of 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

Taking Money Out of Your Business in an S Corp

Some business owners (depending on the business type and phase of growth) will want to take a good portion of the profit out of the business to pay themselves.

Businesses that are good candidates for S corp status have low costs and relatively high profit.

Small businesses with low costs and relatively high profit can be good candidates for S corp tax status.

These two types of businesses are generally good candidates for S corp:

• Service businesses with low overhead and relatively high profit, like electrician businesses
• Small businesses that are in a growth phase and expect to continue seeing high profit compared to expenses

Reasonable Salary and at least $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 for the work performed.

When a business owner elects S corp tax status, they are treated as employees of the business for tax purposes. This means the business owner will no longer be required to pay self-employment taxes on distributions.

The easiest way to understand S corp tax savings is through examples.

S Corp Example 1: Electrician Business

In this example, an electrician starts an LLC and must pay 15.3% self-employment taxes (FICA Medicare and Social Security tax) on her distributions plus normal income taxes.

If the electrician earns 100,000 in net profit (profit after expenses) and distributes the full amount to herself, she will pay $15,300 in FICA self-employment taxes in addition to normal income taxes.

Under an S corp, the electrician is treated as an employee of the business and is no longer subject to self-employment taxes.

S Corp Tax on Reasonable Salary

As an employee of the business, the electrician must pay herself a reasonable salary, which is subject to employee FICA taxes and income taxes.

If the electrician pays herself a reasonable salary of 70,000, they will pay $5355 in FICA taxes on the salary and the business will pay $5355 in FICA on the employees behalf. The total FICA for the S corp is $10,710 compared to $15,300 without S corp status.

This is a savings of $4590.00.

S Corp Tax on Distributions

In an S corp, distributions are no longer subject to self-employment FICA taxes. Instead, distributions pass through to the employee-owner’s individual tax return and are only subject to income tax.

The electrician with 100,000 in net profit will receive a distribution of $26,645 (the remaining net profit after the business pays the $5355 in FICA taxes).

Payroll and Accounting Costs

Business owners that choose S corp status will need to hire payroll and accounting professionals. This cost must be offset by tax savings. We estimate that distribution amounts must be at least $20,000 annually to justify the additional expense.

For the electrician, their payroll and accounting costs must be less than $4590.

Take a look at our Best Payroll Service review and schedule a free accounting consultation to learn more about the cost of payroll and accounting.

S Corp Example 2 : Small Business Growth Phase

After much hard work, a Bakery business has entered its growth phase. In this example, the business owner has probably spent many years reinvesting profit back into the Bakery. They might have even skipped paying herself to grow the business.

The businesses profit now far outweighs costs. There is enough profit to pay the Bakery owner a reasonable salary and significant distributions.

LLCs or Corporations Can Elect S Corp Status

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 by completing IRS form 2553. Visit our How to Elect S corp Status guide to learn more.

If you haven’t formed an LLC or corporation yet, then you can elect S corp when you apply for your Employer Identification Number (EIN). Visit our Start an S Corp guide for step-by-step instructions.

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 Tax Rate

The S corp doesn’t have a specific tax rate because like an LLC or sole proprietorship, S corp income passes through to the owner’s individual tax return. At that point, the income is subject to:

• Federal income tax
• State income tax
• FICA employer and employee taxes

S Corp Federal and State Income Tax Rate

In an S corp, the business owner(s) become employees for tax purposes.

S corp income, including reasonable salary and distributions (draws) passes through to the employee’s individual tax return.

The employee’s reasonable income is subject to federal and state income taxes and employee FICA taxes. Distributions are subject to only federal and state income taxes.

Federal and state income tax rates are based on taxable income, the tax bracket for your taxable income, and your filing status.

FICA Employer and Employee Taxes

In an S corp, the business owner(s) are employees and thus, they aren’t required to pay self-employment tax (full FICA tax) and distributions are only subject to state and federal income tax.

Self-employment Tax Rate: 15.3%

Self-employment tax is basically full FICA taxes (Medicare and Social Security tax) that is required to be paid for every dollar earned by any person. In an employee/employer relationship, the FICA cost is split 50/50. The self-employment tax rate is 15.3%

By electing S corp and being treated as an employee, the business owner pays their portion of FICA on ONLY their reasonable salary. Distributions are only subject to federal and state income taxes.

Example:

In the example above, the electrician has a net profit of $100,000 and would owe 15.3% in FICA self-employment taxes if they didn’t elect S corp tax status. That’s $15,300!
As an S corp, she pays herself a $70,000 salary. She will pay her employee FICA taxes of 7.65% or $5355 as part of her individual tax return. The business pays the other $5355 of the FICA taxes for a total of $10,710 paid in FICA taxes between the employee and the employer.

As an S corp, the business owner receives a total distribution of $24,645 and a reasonable salary of $70,000 for a total of $94,645 (compared to $84700 as a default LLC or sole proprietor).

S Corp Tax Calculator

When deciding whether you should elect S corp status, we suggest using our S corp calculator.

First, you’ll need to estimate your net profit for the tax year. We recommend using a conservative amount that you expect will be consistent year over year.

Next, you’ll need to determine a reasonable salary for the work you do for your business. To determine a reasonable salary for your position, you can compare similar salaries on websites like Glassdoor or the US Bureau of Labor Statistics.

You’ll need to weigh your tax savings against the cost of payroll and accounting services. Take a look at our Best Payroll Service review and schedule a free accounting consultation to learn more about pricing.

How to Start an S Corp

You can start an S corp by electing S corp tax status from the IRS on form 2553 for:

• An existing LLC or corporation
• A new LLC or corporation (we don’t recommend starting a corporation and electing S corp status)

For detailed, step-by-step instructions for starting an S corp in your state, choose your state:

• Alabama
• Alaska
• Arizona
• Arkansas
• California
• Colorado
• Connecticut
• Delaware
• Florida
• Georgia
• Hawaii
• Idaho
• Illinois
• Indiana
• Iowa
• Kansas
• Kentucky
• Louisiana
• Maine
• Maryland
• Massachusetts
• Michigan
• Minnesota
• Mississippi
• Missouri
• Montana
• Nebraska
• Nevada
• New Hampshire
• New Jersey
• New Mexico
• New York
• North Carolina
• North Dakota
• Ohio
• Oklahoma
• Oregon
• Pennsylvania
• Rhode Island
• South Carolina
• South Dakota
• Tennessee
• Texas
• Utah
• Vermont
• Virginia
• Washington
• Washington D.C.
• West Virginia
• Wisconsin
• Wyoming

S Corp Taxes FAQs

Related Articles

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LLC vs. S Corp

How to Start an S Corp