You may have heard that if you’re going to start a business, you need to choose an S-Corp.
In fact, you may have just formed one because so and so said you should. It happens.
So What’s the Big Deal?
Most people form S-Corporations so they can pay less self-employment tax. Regular LLCs must pay self-employment tax on every dollar of net income. S-Corps only pay self-employment tax on the portion of income that is paid out via payroll to the shareholders. The caveat is that the payroll must be reasonable. Per the IRS, all shareholders of an S-Corporation that provide more than minor services to the business are required to be paid a “reasonable salary” – in other words, they want to make sure that business owners aren’t avoiding their portion of self-employment taxes (ie Social Security and Medicare).
How Do I Get Paid?
You’d need to run payroll for yourself if you’re providing more than minor services. You might also take distributions from the company for additional funds outside of your reasonable salary.
How Do I Know What’s Reasonable?
And this is the million dollar question! There are analyses you can do online, and also you should also have a talk with your accountant.
Learn even more about S-Corps below!
The name “S-Corp” comes from the tax law which governs them. It is found in subchapter “S” in the internal revenue code. The tax return for an S-Corp is on an 1120-S and all shareholders/owners receive a K-1 at tax time reporting their portion of the income, expenses, taxable and non-taxable items, based on their percentage of ownership.
You cannot be an S-Corp if you have over 100 shareholders. Shareholders of an S-Corp are limited to individuals, estates, certain tax-exempt entities and all must be either U.S. citizens or permanent residents.
Forming an S-Corp
Before anything, you need to have an entity formed, either an LLC or a Corporation – either one can elect to be an S-Corp. An S-Corp is not an entity specifically, it’s a way for your entity to file its taxes. Think of it as an outfit: it’s not the body, it’s what the body wears.
To tell the IRS that you want your entity to be taxed as an S-Corp, you’ll need to fill out a form (Form 2553) to elect it. Every. Single. Shareholder. Has to consent and sign the paperwork. The election has to be made within about 75 days either from when you formed the entity or from the beginning of the year for it to take hold that year. If you miss the deadline, it won’t take until the following year. Late elections are possible, but not guaranteed. Your state might require additional forms as well.