What people mean by "S corp"

01An LLC is a state filing

You form one with the Ohio Secretary of State. You can do it yourself on their website for a filing fee, and most people do not need help with this part.

It asks for a name and for a statutory agent: someone at an Ohio address who takes legal mail for the business. The company exists once the filing is accepted.

That filing settles who owns the business and how far the owners stand behind its debts. How far that reaches is a question for a lawyer.

What it does not do is change a line of your federal return. There is no "LLC" box on a tax return. What the IRS looks at is how many owners there are, and whether anyone filed something to say otherwise.

02What you already are, if you have never filed anything

• One owner. The business is not treated as separate from you. Its income and expenses go on your own return.
• Two or more owners. It is a partnership. It files its own return and sends each owner a K-1.
• Either way the profit is taxed to the owners, whether or not any of it was taken out.
• An owner working in the business pays self-employment tax on that profit — Social Security and Medicare, both halves rather than one.

03"S corp" is an election, not a kind of company

So "should I be an LLC or an S corp?" is two questions stuck together. You can be both. An LLC can elect it and stay an LLC with the state.

• The election is Form 2553. It has a deadline: two months and fifteen days into the tax year you want it to start from.
• An LLC filing that form does not need a second one to be treated as a corporation for tax. The one filing does both jobs.
• Not every business can. No more than 100 owners, and one class of stock. The owners have to be people, or certain trusts and estates. Another company cannot hold shares, and neither can someone who is not a US citizen or resident.

04What changes on the day it starts

• The business files a return of its own, Form 1120-S, and every owner gets a K-1 from it.
• An owner who works in the business goes on the payroll and gets a W-2 like anyone else on it.
• Payroll brings an EIN, tax deposits through the year, a return every quarter, another one annually, and W-2s each January.
• Wages bring state and local obligations too — a registration and returns for each.
• A late business return is charged a penalty per owner, per month, whether or not the company owed any tax.

05Reasonable compensation

This is the part people learn about afterwards.

An S corporation has to pay an owner who works in it a reasonable wage for that work, before it pays that owner anything else. Reasonable means roughly what the same work would cost from someone else, in a business like yours.

• It is not a figure chosen to suit the tax.
• Set it too low and the IRS can treat what was taken out as wages, and charge the payroll tax on it.
• Somebody has to reach the figure, record how they got there, and keep that record.
• Nothing on this page sets one.

06Where the saving is, and what eats it

Only the wage carries Social Security and Medicare tax. What is left after the wage does not. That gap is the whole of it.

So the saving runs on profit above a reasonable wage, and on nothing else. Against it:

• Payroll, every pay period, all year — a service that runs it or the hours to do it yourself.
• A second tax return each year, and a K-1 per owner.
• A wage is not business profit. There is a deduction that applies to business profit and not to wages, so moving profit into wages shrinks it and hands part of the saving back.
• Social Security tax stops at an amount of wages that is reset every year. Past that point the arithmetic is different.

07When it is the wrong answer

• The profit is small. A reasonable wage can absorb most of it, which leaves little to save on and a payroll to run regardless. The wage is not a number on paper either. It has to be paid, and the tax on it comes due in cash whether the business has the cash or not.
• You want one return. One owner, no payroll, no March deadline. That is a real answer and it is often the right one.
• You want outside money in it. A fund or another company cannot hold the stock, and one class of stock leaves no room for investor terms.
• It holds rentals. Rental profit carries no self-employment tax to start with, so there is nothing there to save. Taking a property back out of a corporation later is taxed as though it had been sold.
• You expect losses and are borrowing to cover them. Money the company borrows does not give a shareholder room to deduct losses. In a partnership it does.

08Undoing it is slow

Drop the election and you generally cannot make it again for five years unless the IRS agrees to it sooner. It is a decision about several years, not one.

Been told you should be an S corp? What decides it is your profit, and what your own work is worth.

Tell us about your situation →

This is general information, not advice about a particular business.