During tax season, we field a lot of questions from clients about S Corporations (S Corps). Here are the 10 most common questions and our answers:
1. What is an S Corp and how does it work?
An S Corp is a tax designation that allows a corporation or LLC to pass income, losses, deductions, and credits through to shareholders to avoid double taxation.
2. How is an S Corp different from an LLC?
- LLC: More flexibility, no strict payroll requirements, but subject to self-employment tax on all income.
- S Corp: Avoids double taxation typical of a C Corp while requiring shareholders to take a salary.
3. What are the benefits of electing S Corp status?
- Avoids double taxation (profits flow through to shareholders).
- Allows self-employment tax savings by splitting income into salary and distributions.
- Provides liability protection for owners.
- Easier to transfer ownership than an LLC.
4. How does an S Corp help reduce self-employment taxes?
Owners pay payroll taxes only on their “reasonable salary.” The remaining profits (distributions) are not subject to self-employment taxes like an LLC’s income is.
5. What is a reasonable salary for an S Corp owner?
The IRS requires owners to take a “reasonable salary” before distributions. A reasonable salary depends on:
- Industry standards
- Business profits
- Job responsibilities
Failure to pay a reasonable salary may trigger IRS audits. We recommend that you consult with your accountant for advice on your specific situation.
6. How are S Corp distributions taxed?
- Salary: Subject to payroll taxes (Social Security & Medicare).
- Distributions: Taxed at the shareholder’s personal income tax rate but not subject to self-employment tax.
7. Do S Corps pay corporate taxes?
No, S Corps do not pay federal corporate income tax. Profits and losses pass through to shareholders, who report them on personal tax returns. However, some states impose their own S Corp taxes (e.g., California’s $800 minimum franchise tax).
8. Can an LLC elect S Corp taxation?
Yes, an LLC can elect to be taxed as an S Corp by filing Form 2553. The business structure remains an LLC, but it gets the tax benefits of an S Corp.
9. Who can and cannot own an S Corp?
S Corp ownership is restricted to:
✅ U.S. citizens or resident individuals
✅ Certain trusts and estates
🚫 No non-resident aliens, partnerships, corporations, or most LLCs can own shares in an S Corp.
10. How do I form an S Corp?
- Register a corporation or LLC in your state.
- File IRS Form 2553 within 75 days of formation or by March 15 for an existing business.
- Follow payroll and tax rules to maintain compliance.
Need Help?
📞 Call us at (703) 672-1225
📧 Email us at payroll@paysteady.com