S-Corp election: when it saves money and who can't use it
An S corporation isn't a different kind of company. It's a tax status that an LLC or a corporation can elect. For profitable US owners it can lower self-employment tax. For others it adds payroll and paperwork for nothing.
How it saves tax
In a regular LLC, a US owner pays self-employment tax on all of the business profit. As an S-Corp, the owner who works in the business takes a reasonable salary through payroll, and the rest of the profit comes out as distributions that aren't subject to self-employment tax.
The salary has to be reasonable for the work done. Paying yourself a token salary to avoid payroll taxes is what the IRS looks for.
When it usually makes sense
- the profit is steady and well above what you'd pay yourself as salary;
- you're ready to run payroll and file quarterly payroll returns;
- you live in the US, or all owners are US persons.
At low profit, the cost of payroll and the extra return can wipe out the savings.
Who can't elect
- companies with a nonresident alien owner;
- companies owned by another corporation, a partnership or most LLCs;
- companies with more than 100 shareholders;
- companies with more than one class of stock.
How to elect
File Form 2553, signed by every shareholder, no later than 2 months and 15 days after the start of the tax year you want it to apply to, which is March 15 for a calendar year. A new company counts from the day it started. The IRS can accept a late election if you have reasonable cause.
Once elected, the company files Form 1120-S by March 15 and gives each owner a Schedule K-1.