S Corps 101

Maximize Your Tax Savings: Why Every Small Business Should Consider an
S Corp

Are you a business owner who’s been told to consider becoming an S Corporation, or S Corp, but you’re not quite sure what that means? If you’ve been caught up in the confusion of tax code articles and complex regulations, you’re not alone! In this blog, we’re going to break down the basics of S Corps, and give you the insights you need to decide if this structure is right for your business. Don't forget to download our free Accountable Plan and check out our insightful YouTube video on S Corps.

Below, we break down the key things you need to know regarding S Corps.

1. What is an S Corp?
2. S Corp Requirements
3. How to Become an S Corp
4. How Are S Corps Taxed?
5. Pros and Cons of Becoming an S Corp
6. Key Requirements for Staying in Good Standing
   1. Accountable Plan
   2. Reasonable Compensation
7. When Does It Make Sense to Become an S Corp?
8. Conclusion: Is an S Corp Right for You?

What is an S Corp?

First, let’s clear up a common misconception: an S Corporation, or S Corp, is not a type of business entity. Instead, it’s a special tax status that can be elected by corporations or LLCs. Think of it as a tax “costume” that offers unique benefits for business owners. By becoming an S Corp, your business can combine the advantages of both corporations and partnerships. S Corps are a hybrid between C-Corps and LLCs. They provide the liability protection and structure of a corporation but allow for taxation similar to a partnership or sole proprietorship. This flexibility is why S Corps are a popular choice for small business owners.

S Corp Requirements: Does Your Business Qualify?

Not every business can become an S Corp. The IRS has specific qualifications that must be met, including:

• Your business must be a U.S.-based corporation or LLC.
• You can have no more than 100 shareholders or members.
• Shareholders must be individuals. No corporations, partnerships, or non-U.S. residents allowed.
• You can only have one class of stock.
• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

If your business meets these requirements, you may be eligible to elect S Corp status. But remember, there are compliance steps to follow, such as filing an annual Form 1120-S, payroll tax forms (940/941/944), and holding an annual board meeting.

How to Become an S Corp

Becoming an S Corp is relatively straightforward. Here’s how to do it:

1. Ensure your business meets the IRS requirements.
2. File Form 2553 (“Election by a Small Business Corporation”) with the IRS within 75 days of starting your business or within 75 days of the start of the tax year you want the S Corp status to take effect. Don’t worry if you miss the deadline; there are provisions for late election relief.
3. Make sure all shareholders consent to the election by signing the form.

Once submitted, the IRS will confirm your S Corp status by mail. Be sure your address is up to date with them!

S Corp Compliance: Key Requirements for Staying in Good Standing

Electing S Corp status comes with specific compliance obligations to keep your tax benefits and avoid potential penalties. Here are the critical requirements for S Corp owners to keep in mind:

1. Annual Tax Filings
Income Tax Return (Form 1120-S): Each year, S Corps must file Form 1120-S to report income, gains, losses, deductions, and credits. The information flows through to shareholders, who report it on their personal tax returns.
Payroll Tax Forms (Forms 940, 941, or 944): S Corp owners who work in the business and receive a salary need to file payroll tax forms. These forms report payroll taxes and employee wages, helping the IRS verify that a "reasonable salary" is paid to owner-employees.

2. Annual Board Meeting
S Corps are required to hold at least one annual meeting of the board of directors and shareholders. During this meeting, the board should review the financial performance, set future goals, and document major decisions. Documenting minutes of these meetings helps maintain your corporate veil and can prove valuable in the event of an audit.

3. Accountable Plan
An Accountable Plan allows S Corps to reimburse employees (including owner-employees) for business expenses without those reimbursements being taxable. This is one of the most overlooked benefits for S Corps. To set up an Accountable Plan, the reimbursed expenses must be:

• Business-related.
• Accounted for within a reasonable time frame.
• Repaid if any excess is reimbursed.

This plan can be a great way to maximize tax savings by reimbursing for home office expenses, mileage, and more. We offer a free sample Accountable Plan for you to download!

4. Reasonable Compensation
One of the most critical aspects of S Corp ownership is paying yourself a “reasonable” salary. The IRS requires that S Corp owners receive a reasonable wage before taking distributions. But what exactly is reasonable? According to the IRS, it’s the amount that would typically be paid for similar work by similar businesses.

The important thing to remember is that your salary is subject to payroll taxes, while distributions are not. This is why the IRS closely monitors S Corps to ensure owners are not avoiding payroll taxes by taking only distributions.

How Are S Corps Taxed?

S Corps are considered “pass-through entities” for tax purposes, which is a significant benefit. This means the business itself does not pay federal income taxes. Instead, income, losses, deductions, and credits are passed through to the shareholders, who report them on their personal tax returns.

This setup avoids the “double taxation” experienced by C Corporations, or C Corps, where profits are taxed at both the corporate and individual levels. We’ll show you a few examples of S Corp tax savings later on!

Pros and Cons of Becoming an S Corp

While there are plenty of benefits to becoming an S Corp, it’s essential to weigh both the pros and cons:

Pros:

• Limited Liability: Just like with regular corporations, your personal assets are protected from business liabilities.
• Pass-Through Taxation: You could see significant tax savings.
• Self-Employment Tax Savings: Owners can pay themselves a salary and take the rest of the profits as distributions, reducing self-employment taxes.
• Credibility: S Corps are often viewed as more professional or credible than LLCs or sole proprietorships.

Cons:

• Ongoing Costs: Managing payroll and additional paperwork can increase operational expenses.
• Increased Paperwork: S Corps must hold annual board meetings and maintain formal records.
• Salary Requirements: Owners must pay themselves a “reasonable” salary, which is subject to payroll taxes.
• IRS Scrutiny: The IRS keeps a close eye on S Corps, especially when it comes to salary vs. distributions.

When Does It Make Sense to Become an S Corp?

The decision to become an S Corp depends on your business’s profits. Typically, it starts to make sense when your annual profits hit around $40-50k. At this point, the tax savings can outweigh the added costs of compliance and payroll.

Conclusion: Is an S Corp Right for You?

While S Corps offer significant advantages, they’re not suitable for every business. It’s crucial to consult with a CPA before making any decisions about your business structure. Our team at Iota Finance is here to help with expert advice and personalized guidance. If you're considering an S Corp election or just need a second opinion, schedule a free consultation with us today.

Plus, don’t forget to download our free accountable plan to make managing reimbursements a smoother process!

Stay on top of your business’s financial health—because it’s not just about taxes, it’s about strategy.

About The Author

Igor Tutelman, CPA is the Managing Partner of Iota Finance and the writer behind Not Your Father’s Accountant™. Igor started his career working for large corporations in tax and corporate finance roles before leaving for the world of tech startups. After a successful exit, he took some time off and returned to the accounting industry to build the firm he wished he had as an entrepreneur - Iota Finance. Iota Finance is a remote accounting firm that focuses on helping startups and small businesses with taxes, accounting, bookkeeping, payroll, and fractional CFO services.

Have questions or need more detailed guidance? Contact us at Hello@Iota-Finance.com or Schedule a Free Consultation, and we’ll help you get started.