S Corporation

Imagine being a corporation but not paying corporate taxes and imagine being self-employed and not paying self-employment taxes. That's what an S corporation is. S corporation, instead of paying 21% tax on their net income passes it on to its shareholders who generally report it as a passive income on their personal tax return. Since it's a passive income it's not subject to self-employment taxes unlike income from sole props and general partnerships. However, there are few limitations S corporations have:

  • There can only be 100 shareholders.

  • All shareholders must be US residents.

  • Net income must be distributed to shareholders and is later taxed on a personal level.

  • Only 1 class of stock can be issued.

Registration

To register, follow the same steps as when registering a c corporation. Once registered, IRS will by default classify it as a C corporation. To change it to S, form 2553 must be sent to IRS within 2 month and 15 days after the registration. Existing C corporations, willing to make and S corporation election must send it no later than 2 months and 15 days after the start of the tax year, typically March 15th. For example, a new corporation was formed on June 10, 2023. August 21st, 2023 will be the last day to make S corporation election. If the election is made later, the corporation will be an S corporation for 2024 but will remain C corporation for 2023. Similarly, if an existing corporation wants to be treated as an S corporation beginning from 2024 the 2553 needs to be filed before March.

Form 2553

You can download the form 2553 here. Fill out and mail or fax it to the address / number on the 1st page of the form. The form may seem confusing at a glance but, unless you are filing late or trying to change your calendar year you only need to fill out pages 1 and 2. Let’s assume a newly formed corporation on June 1. 2023 wants to make an S corporation election.

  • Part I enter the name, address, EIN, date and state of incorporation.

  • D: leave blank unless name or address change

  • E: June 1, 2023, in our case (or the date you want it effective)

  • F: calendar year (selecting anything else may require additional filings and approvals)

  • G: leave blank unless over 100 shareholders

  • I: leave blank in our case, only fill out if filing late.

  • Sign in the bottom of the

  • On page 2 J: Enter information about each shareholder and have them sign.

Taxation

S corporations, as mentioned, do not pay federal income tax, however, states may impose an income or revenue tax on them. In our state’s section we’ll cover every single state’s approach to S corporation. The 1120S information return must be filed typically by March 15. Failure to file can cost $220 for each shareholder for each month or part of the month the return is late. For example, an S corporation with 3 shareholders that filed their tax return on March 16th can face a penalty of $660 (1-month late x $220 x 3 shareholders). The same return filed on June 5th can cost the company $1,980 (3 months late x 220 x 3 shareholders).

Case:

Kelsi runs her Doe's Bakery LLC and makes a net profit of $100,000. To make things easier she lives in a zero-income tax state.

Without 2553 election $100,000 would appear on her schedule c as a self-employment income and she'd be subject to $14,130 self-employment tax and $9,752 in Federal income tax making her total tax liability $23,822.

With 2553 election, she needs to pay herself a reasonable salary. Typically, 40% of net income is considered reasonable. Thus, she pays $40,000 in salary that is subject to 15% payroll taxes (between employer and employee responsibilities - more about it in our “hire employees”section) and $60,000 is distributed as a passive income. On her personal tax return 40,000 salary and 60,000 passive income are subject to $14,774 federal income tax. In addition, she pays $6,000 in payroll taxes making her total tax liability $20,774. $3,084 less than LLC or Sole proprietorship would pay on the same income.

Paying Yourself

There are 2 main ways S corporation owners can pay themselves:

  • Payroll

  • Distribution

While there are no laws on proportions, IRS requires a reasonable salary for S corporation owners who actively oversee and participate in its operations. Single owner S corps often pay themselves around 40% of the net income via payroll and 60% as a distribution. The key difference is that payroll is subject to around 15% payroll taxes.