When Should I (or Should I Not) Become An S Corp?

Posted on March 22, 2022

First off, if you missed our Blog Post or Podcast Episode last week on “What Is An S Corp?” you will definitely want to check that out as it leads into this one.

Also, I just want to let you know that we did an entire series on S Corporations on both our Blog and Small Business Tax Savings Podcast, so if you want to dig deeper from what we discuss today, check that out. 

Everything You Need To Know About S Corporations

We also have a very in depth deep dive into S Corporations as a Module in our Tax Minimization Program. If you are a member you will want to go through that entire module, if you are not a member now is a great time to join!

Alright, so with all that being said, lets dive into days topic, when does it makes sense (or doesn’t make sense) to be an S Corp!

What Are The S Corp Requirements?

Before we dig into that, lets first discuss the requirements to even elect S Corp status.

  • Must be organized initially as an LLC or Corporation. Remember this is simply a tax election so you must first have a company open.
    • If you are currently operating as a Sole Proprietor you will need to open an LLC or Corporation and then elect S Corp status. 
  • Shareholders may be individuals, certain trusts, or estates. May NOT be a: partnership, corporation, or non-resident alien.
  • Cannot have more than 100 shareholders.
  • Can only have one class of stock.
  • All shareholders must consent to the election.

When Should I NOT Be An S Corporation?

Often times accountants are very quick to jump on the S Corp band wagon but there are some things we should discuss on when it really may not make sense for you to be one.

  • Your Business is Small
    • As we talked about last week, S Corporations have some disadvantages, specifically a separate business tax return and W2 payroll required. If you are a small business making say $20,000 a year, these added compliance costs will eat into all of your tax savings you may get with an S Corp.
  • You Have Foreign Owners
    • As we talked about above, a non-resident alien cannot be an owner of an S Corp so if you have foreign investors you are not allowed to elect the S Corp status.
  • Unfavorable State or Local Laws
    • There are a few (not many) states and localities in the US that may have an unfavorable treatment to S Corp which could eat at some of your savings. You would need more in-depth analysis to see if it makes sense.
    • Examples are New York City and Tennessee. If you live in one of these, you will want to talk to a tax professional to go through your specific scenario deeper. 
  • You Have Another High Paying W2 Job
    • The biggest reason to elect S Corp is for self employment tax savings. If you have a high paying W2 job you may be maxing out social security taxes ($147k in 2022) already and thus your savings would only be roughly 3%. Again this could minimize your savings under an S Corp unless your S Corp is earning $200k+.
  • Expecting Business to Decrease or Close Soon
    • If you are expecting your business profits in the future to be low or you plan to close your business in the near future, again an S Corp may not make sense due to the added compliance costs.
  • Planning to Go Public Soon or Have Lots of Investors
    • With an S Corp you are limited to only one class of stock and 100 shareholders so if you plan to go public or bring on different type of investors an S Corp setup likely would not be the greatest fit.

As always with a decision like this you should be running it past your tax advisor to ensure that this decision is the right one.

When Should I Be An S Corporation?

Alright, now lets talk about those of you that should elect S Corp status. Again, these are all general guidance and your specific scenario should be discussed with a tax advisor.

  • Business Profit of $50,000 or More
    • As we know with the added compliance costs (separate business tax return and payroll) of an S Corp, you want to make sure you have enough profit to outweigh those added costs. $50,000 is a good benchmark for that!
  • Expect to Maintain Profit of $50,000 or More
    • Having an on-going expectation of that income level is also key. If you are making $50,000 this year but expect all future years to be $15,000 then it may not make sense to get the benefits for just one year when it may hurt you down the road.
  • Solo Owner / A Partner or Two
    • If you are a solo business owner or just have a partner or two, an S Corporation will likely play in well with that. We are going to be talking next week about different entity structure setups with multiple businesses or partners.
    • Key thing here is that typically we will go a different route if there are a lot of owners or outside investors.
  • No Other High Paying W2 Job
    • Most people we put in an S Corp, it is their main source of income. They do not have other W2 jobs that they earn a high salary in. Their business is their high income.

Like I said in the beginning I highly recommend you check out our Blog Post or Podcast Episode last week on “What Is An S Corp?” or our series Everything You Need To Know About S Corporations if you want to learn more about S Corps.

We also do a very thorough deep dive on S Corporation in our Tax Minimization Program where we go through:

  • S Corporation Strategy
  • Payroll Tax Savings Calculator – Run scenarios of your specific situation to see what savings you would have.
  • S Corporation Disadvantages
  • Deciding If An S Corp Is Right For You
  • Exact Steps on How To Elect S Corp Status
  • How to Determine a Reasonable Salary
  • Reasonable Salary Worksheet
  • How to Setup Payroll for An S Corp
  • Steps You Need to Take After Electing S Corp Status
  • and so much more…

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