S Corporation Election

Tax Strategy
|
Election
|
Updated
2/18/2023

How It Works

The S Corporation Election is a strategy that business entities, including sole proprietorships and partnerships, can use to avoid self-employment taxes.

The business makes an election with the IRS to be treated as an S corporation, which exempts the business owner from self-employment taxes. As an S corporation, payments to a business owner must be treated as compensation to the extent that that the payments are reasonable compensation for services provided to the business. The compensation is subject to employment taxes.

In many cases, the employment taxes paid by the business are less than the self-employment taxes that the owners would have paid had they not made the S corporation election.

Eligibility

Before implementing the S Corporation strategy, confirm the following:

  • You have self-employment income from Schedule C, Schedule F, or Partnership K-1;
  • The S Corporation will generate taxable income after paying reasonable wages to its shareholders;

Furthermore, confirm that the business passes all of these tests:

  1. The business is a domestic corporation or is an entity that is eligible to elect corporation per Form 2553 instructions.
  2. The business has less or equal to 100 shareholders. The following are counted as one shareholder: Spouses and their estates; and Family members and their estates.
  3. Shareholders are individuals, estates, not-for-profit organizations or qualified subchapter S trusts (QSSTs) or electing small business trusts (ESBTs).
  4. The business has no nonresident alien shareholders (except ESBT beneficiaries).
  5. The business has only one class of stock
  6. The business is not: A bank or thrift institution using the reserve method for bad debts; An insurance company under subchapter L; A domestic international sales corporation (DISC) or former DISC.
  7. The business has or will adopt one of the following tax years: December 31; Natural business year; Ownership tax year; Section 444 tax year; 52-53 week tax year based on above; Other tax year with business purpose;
  8. Each shareholder consents to the S corporation election.

Action Items

To use this strategy

  • Form a corporation or LLC in the primary state in which you conduct business.
  • Apply for an EIN from the IRS with Form SS-4 or through their website.
  • File form 2553: Within 2 months and 15 days after the beginning of the tax year in which the election takes effect; or At any time during the tax year preceding the tax year in which the election takes effect.
  • Open payroll accounts with the state and establish a salary for for the business owner.
  • Maintain accurate books and segregated assets for the S corporation.

Limits (2023)

There are no income limits for S corporations. However, be mindful of employment tax rates and income limits that will impact the tax savings of this strategy, including:

  • $147K Social Security wage limit and 6.2% tax rate
  • 1.45% Medicare tax on wages up to $200K; wages above $200K subject to 0.9% additional Medicare tax
  • 15.3% self-employment tax on earnings up to Social Security wage limit; 2.9% on excess earnings

IRC References

I.R.C § 1361 S corporation defined -

“For purposes of this title, the term “S corporation” means, with respect to any taxable year, a small business corporation for which an election under section 1362(a) is in effect for such year.”

This content is for informational purposes only and does not constitute legal, business, or tax advice. You should consult your own attorney, business advisor, or tax advisor regarding matters mentioned in this post. We take no responsibility for actions taken based on the information provided.

Get your free custom quote.

It takes less than a minute to start.

© 2022 Putnam CPA Group, PLLC
Made in Virginia