What is an S-Corp?
A tax election that can save you thousands of dollars in self-employment taxes, ideal for profitable businesses with consistent earnings.
Form my S-Corp nowImportant clarification
S-Corp is NOT a separate entity type at the state level. It is a tax election made with the IRS (Form 2553) after forming an LLC or Corporation. You first form the legal entity in your state, then elect S-Corp taxation to gain tax benefits.
Definition
An S-Corporation is a special tax status granted by the IRS that allows the company's profits, losses, deductions, and credits to pass directly to shareholders for federal tax purposes, avoiding the double taxation of a traditional C-Corp.
The main benefit of electing S-Corp is that the owner can pay themselves a reasonable salary (subject to payroll taxes) and receive the rest of the profits as distributions, which are not subject to the 15.3% self-employment tax.
What is it for?
The S-Corp election mainly serves to reduce the tax burden of profitable businesses, allowing income to be split between salary and distributions, reducing the total self-employment tax paid.
How does the process work?
Form your LLC or Corporation
You first need a state-level legal entity (LLC or C-Corp) before you can elect S-Corp status.
File Form 2553 with the IRS
This free form formalizes your S-Corp tax election. It must be filed within the first 75 days of the tax year.
Establish a reasonable salary
The IRS requires you to pay yourself a "reasonable" salary based on your industry before taking additional distributions.
Process payroll for your salary
You will need a payroll system to pay payroll taxes on your salary as an employee.
File corporate taxes (Form 1120-S)
Annually, the S-Corp files its own informational return with the IRS.
Advantages and Disadvantages
Advantages
- ✓Significant savings on self-employment taxes on distributions
- ✓Maintains limited liability protection
- ✓No double taxation (unlike C-Corp)
- ✓Health benefit deductions for owner-employees
- ✓Greater credibility for established businesses
Disadvantages
- !Requires processing payroll, adding cost and complexity
- !IRS closely scrutinizes that the "reasonable salary" is fair
- !Limit of 100 shareholders, all must be US citizens or residents
- !Can only have one class of stock
- !Requires filing an additional tax return (1120-S)
- !Tax benefits are only meaningful with consistent, significant profits
Who should elect S-Corp?
- ✓Businesses with consistent net profits of $40,000+ per year
- ✓Owners already operating as an LLC looking to save on taxes
- ✓Consultants and professionals with stable income
- ✓Businesses with few owners (fewer than 100 shareholders)
- ✓Companies ready to process formal payroll
When is it NOT the best option?
- ✕If your business is just starting with few profits
- ✕If you do not want the complexity and cost of processing payroll
- ✕If you have foreign shareholders or more than 100 shareholders
- ✕If you plan to seek venture capital or multiple stock classes
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