S Corporation Tax Advantages
IRS S Corp Definition:
S corporations are corporations (or any 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. See Internal Revenue Code 26 USC Subtitle A, Chapter 1, Subchapter S to learn more.
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: