What is an S-Corp?

Many small businesses are told they should “create an S-Corp” but are not really told what that means or why they might do that. In reality, there is no such thing as an “S-Corp.” Rather, certain businesses can elect to be taxed as an “S-Corp.”

We’ll explain what that means in this post.

Who can make an S-Corp election

According to the IRS, to qualify for S-Corporation status today an LLC or corporation must:

• Be a domestic LLC or corporation
• Have only allowable shareholders

• May be individuals, certain trusts, and estates and
• May not be partnerships, corporations or non-resident alien shareholders

• Have no more than 100 shareholders
• Have only one class of stock
• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

When to elect S-Corp status

You can make an S-Corp election when you create your business, or at the beginning of each calendar year. However, you really shouldn’t make this election until each owner of the business is making more than a “reasonable salary” as defined by the IRS. If you are making enough to pay the owners a salary and have profits left over, then it might be a good idea to make the election. Regardless, you should always talk to an accountant before making the election to make sure it makes sense for you.

The tax benefit

This is really the biggest benefit to making an S-Corp election.

After making the election, your business must pay yourself a salary. That salary is then subject to all normal taxes, including employment taxes. However, when you distribute excess profits to the owners, those owners will not have to pay employment taxes on those profits. That means they can reduce their tax liability by about 15% on those profits. And that can add up to a big savings.

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Related Guides

There’s so much more to learn! Here are a few related guides you should read:

• Sole Proprietors: When and how to operate as a sole proprietor
• LLCs & Corporations: When and how to start an LLC or corporation
• DBAs: What is a DBA/Fictitious Name?