What is an S corp?
An S corporation isn't a kind of business you form. It's a tax election an eligible corporation or LLC makes with the IRS — and for the right owner it cuts self-employment tax. For the wrong one it just adds cost. Here's how it works, in plain terms.
The short answer
An S corporation is a corporation — or an LLC — that has elected to be taxed under Subchapter S of the tax code, which is where the name comes from. Instead of paying corporate income tax, it passes its income, losses, deductions and credits through to its owners, who report their shares on their own returns. That avoids the double tax a regular corporation's profit faces.
The part that matters to most owners: in an S corporation, an owner who works in the business is paid a salary, which carries payroll tax, and can take the rest of the profit as distributions, which don't. A sole proprietor pays self-employment tax on all of their profit.
S corp, LLC, C corp: what's the difference?
The confusion comes from mixing two different things. An LLC or a corporation is a legal entity you form under your state's law. An S corporation is a federal tax treatment one of them can choose. So an LLC can be taxed as an S corporation without changing what it is legally. When an LLC should elect.
| Sole proprietor or one-owner LLC | S corporation | C corporation | |
|---|---|---|---|
| Who pays income tax | You, on all the profit | The owners, on their shares | The corporation, at 21% — then owners again on dividends |
| Self-employment or payroll tax | On all the profit | On the owner's salary only | On salaries only |
| Tax return | Schedule C on your own return | Form 1120-S, and a K-1 for each owner | Form 1120 |
| Payroll for the owner | No | Yes — a reasonable salary | Yes, if paid |
How an S corporation is taxed
- The business files Form 1120-S but usually pays no federal income tax itself. Each owner gets a Schedule K-1 showing their share of the profit, and pays tax on it — whether or not they take the cash out.
- An owner who works in the business takes a salary, run through payroll with withholding. It has to be reasonable for the work. How that's judged.
- The rest can come out as distributions, with no Social Security or Medicare tax.
- A few things are still taxed at the business level — certain built-in gains and passive income for corporations that used to be C corporations — and some states and cities tax S corporations or don't recognize the election at all.
Who can be an S corporation
- A domestic corporation, or an LLC that elects to be taxed as one
- 100 shareholders or fewer
- Only individuals, estates and certain trusts as shareholders — no partnerships, corporations or nonresident aliens
- One class of stock: every share has the same rights to distributions and liquidation proceeds
How to become one
File Form 2553 with the IRS, signed by all the shareholders, within two months and 15 days of the start of the tax year you want it to take effect. For a calendar-year business electing for next year, that's by March 15. The IRS has a relief procedure for elections filed late. After that: set up payroll, pay yourself a reasonable salary, and file Form 1120-S each year.
Does an S corp save money?
Sometimes. The saving is the self-employment tax on the profit above your salary. Against it: payroll every pay period, a separate business tax return, and often a smaller qualified business income deduction, because your salary doesn't count toward it. For many owners it starts to pay somewhere between $60,000 and $120,000 of profit, depending mostly on the salary. The S corp calculator works it out for your numbers and says no when it doesn't pay; the self-employment tax calculatorshows what you pay now.
When it doesn't fit
- Profit is modest — the running costs outweigh the saving.
- The income is rent, which isn't subject to self-employment tax anyway.
- An owner is a company, a partnership or a nonresident alien.
- You plan to raise venture capital, where investors usually expect a C corporation.
Whether an S corporation fits your business is a question for your CPA or tax attorney before you file anything.
Sources
- IRS, S corporations — pass-through taxation, eligibility, Form 2553, Form 1120-S and K-1s, and entity-level taxes
- IRC §1361 and §1362 — who can elect, and when the election is due
- IRS Form 2553 — the election
- IRC §11(b) — the 21% corporate rate
General information, not advice for your situation. Whether a strategy fits depends on your facts — talk to your CPA or tax attorney about whether you qualify before you put it in place. Your accountant remains responsible for your return.
Know where yours stands, all year.
OpenYear reads your books, shows which strategies fit your business and why, and keeps the records each one needs — ready for your accountant. It's built for owner-operated S corporations.