What is an S Corp?

Introduction

If you're a business owner paying self-employment taxes, you've probably heard people talking about "electing S Corp status" to save on taxes. But what exactly is an S Corporation, and is it right for your business? In this comprehensive guide, we'll break down everything you need to know about S Corp elections.

What is an S Corporation?

An S Corporation isn't actually a business entity type - it's a tax election. This is one of the most misunderstood aspects of S Corps. You don't "form" an S Corporation; you elect S Corporation tax treatment for your existing LLC or corporation.

The S Corp election is made with the IRS by filing Form 2553 (Election by a Small Business Corporation). Once approved, your business is still legally an LLC or corporation, but the IRS treats it differently for tax purposes.

How S Corp Tax Treatment Works

To illustrate how S Corp Tax Treatment works, let's compare two different setups.

1. Traditional LLC or Sole Proprietorship:

   1. All your business profit is subject to self-employment tax (15.3%)

   2. This covers Social Security (12.4%) and Medicare (2.9%)

   3. You pay this on every dollar of profit

2. S Corporation Tax Treatment:

   1. You pay yourself a reasonable salary (subject to payroll taxes - essentially the same as self-employment tax)

   2. The remaining profit is distributed to you as distributions

   3. Distributions are NOT subject to self-employment tax. This is where the tax savings happen. Let's dive in further with some numbers.

Example Comparing LLC vs SCorp with Numbers:

For this example, let's say your business makes $150,000 in profit:

1. As an LLC: You pay 15.3% self-employment tax on the full $150,000 = $22,950

2. As an S Corp: You pay yourself $80,000 salary (payroll taxes) and take $70,000 in distributions

3. You only pay payroll taxes on the $80,000, saving approximately $10,710 annually

Not a tax professional, and still not fully following? We got you! We built detailed calculators to show you in a more clear way how S Corps save you money:

• [See our calculator to find your potential savings →]

Who Should Elect S Corp Status?

The answer: It depends. I know, super clear, BUT the S Corp election isn't right for everyone. You need to weigh the benefits against the costs and requirements of simply existing as an S Corp.

The Benefits:

1. Significant tax savings on self-employment taxes (see calculator linked above)

2. Pass-through taxation - profits flow to your personal return, no double taxation

3. Potential QBI deduction - you may still qualify for the Qualified Business Income deduction

4. Credibility - some clients/vendors perceive S Corps as more established

The Costs and Requirements:

1. Election Process

   1. Must file Form 2553 with the IRS. If you're unsure how and when to file this form, you're in luck, we created an entire write up just for you: [How To Become An S-Corp]

   2. Strict deadlines (typically within 2 months and 15 days of the start of the tax year)

   3. Late elections require special procedures

2. Payroll Requirements

   1. Must pay yourself "reasonable compensation" via W-2 payroll

   2. Setting up payroll costs money (payroll service fees typically $500-$2,000+ annually)

   3. Ongoing payroll tax filings required:

      1. Federal quarterly 941 forms

      2. State quarterly payroll tax returns

      3. Annual W-2s and W-3s

      4. Federal and state unemployment taxes

      5. Workers' compensation insurance in some states

      6. Whew, that's a long list!

3. Corporate Formalities

   1. Must maintain corporate records

   2. Hold annual board meetings (even if you're the only shareholder)

   3. Keep meeting minutes

   4. More stringent recordkeeping requirements

4. Tax Return Complexity

   1. Must file Form 1120-S (S Corporation tax return)

   2. More complex than Schedule C (sole prop) or Form 1065 (partnership)

   3. Typical cost: $1,000 - $3,000+ for professional preparation

   4. Due date: March 15th (earlier than personal returns)

5. Ongoing Compliance

   1. Must maintain proper corporate/LLC structure

   2. Separate bank accounts required

   3. Cannot commingle personal and business funds

   4. Violating S Corp rules can result in IRS revoking your election

The Break-Even Point

Most tax professionals recommend S Corp election when your business profit exceeds $60,000-$80,000 annually. Below this threshold, the costs often outweigh the tax savings.

That's why we built our calculators for you - to help make this decision. Use our calculators to:

1. Calculate your potential S Corp tax savings

2. Compare S Corp vs sole prop/partnership costs

3. Determine your optimal salary vs distribution ratio

Eligibility Requirements

Not every business can elect S Corp status. Your business must meet these IRS requirements:

1. Be a domestic corporation or LLC

2. Have only allowable shareholders (individuals, certain trusts and estates - NOT partnerships or corporations)

3. Have no more than 100 shareholders

4. Have only one class of stock

5. Not be an ineligible corporation (certain financial institutions, insurance companies, etc.)

Summary

S Corporation election is a tax strategy that can save business owners thousands in self-employment taxes annually. By paying yourself a reasonable salary and taking remaining profits as distributions, you only pay payroll taxes on the salary portion - not the distributions.

However, S Corp status comes with real costs: payroll setup and maintenance ($500-$2,000+/year), more complex tax returns ($1,000-$3,000+), and ongoing corporate compliance requirements. Most tax professionals recommend considering S Corp election when your business profit exceeds $60,000-$80,000 annually.

Ready to see if S Corp election makes sense for you? Use our free calculators to calculate your potential tax savings and determine your optimal salary-to-distribution ratio. The numbers will help you decide if the savings justify the costs.

[Calculate Your S-Corp Savings Now →]

Remember: Every business situation is unique. Always consult with a qualified tax professional before making the S Corp election to ensure it's the right choice for your specific circumstances.

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Legal Disclaimer: The information provided in this article is for educational purposes only and should not be construed as tax, legal, or financial advice. Tax situations are highly individual and complex. Always consult with a qualified tax professional, CPA, or attorney before making any decisions regarding S-Corporation elections, entity structure changes, or tax planning strategies. Calculator results are estimates only and may not account for all relevant tax provisions or your specific circumstances. SCorpGuide.com and Forever Exploring LLC are not liable for any decisions made based on information provided on this site. For complete terms, see our Terms and Disclaimers.