What is the Meaning of an S Corporation?

I run an S Corp and the biggest practical difference for me has been payroll and compliance.

Once you're operating as an S Corp and working in the business, you're dealing with payroll, W-2 wages, employment taxes, bookkeeping and a separate business tax return.

The company generally files Form 1120-S, and shareholders receive Schedule K-1 reporting their share of the company's income and other items.

That is very different from simply running a sole proprietorship and reporting business income directly on Schedule C.

Also, S Corp status doesn't mean the business has no taxes. You can still have federal income tax at the shareholder level, payroll taxes, state-level taxes and other obligations depending on where the business operates.

For me, it became worthwhile only after the business had enough consistent profit to justify the additional administration.

I would compare the total picture rather than focusing only on the potential self-employment-tax difference.

I was confused about the LLC/S Corp distinction too.

An LLC is a business entity created under state law, while S Corporation status is a federal tax election under Subchapter S of the Internal Revenue Code.

So an LLC can potentially elect to be taxed as an S Corporation if it meets the eligibility requirements.

One important eligibility issue is ownership. Generally, S Corporations can have no more than 100 shareholders, and shareholders generally need to be individuals, certain trusts or estates, and certain tax-exempt organizations. Nonresident aliens generally cannot be S Corp shareholders.

That last point surprised me because I had assumed anyone living overseas could own shares.

There are also restrictions involving other corporations and certain types of entities.

I wouldn't make the election just because someone says “S Corp means less tax.” Whether it makes financial sense depends on the business's profit, reasonable compensation, payroll costs, state taxes, accounting costs and other factors.

The thing that helped me understand it was realizing that an S Corporation is primarily a federal tax status/election, rather than simply another type of state-law business entity.

For example, you can have an LLC that is eligible to elect to be treated as an S Corporation for federal tax purposes. The LLC doesn't necessarily stop being an LLC under state law just because it makes the federal S Corp election.

I originally formed an LLC and later discussed S Corp taxation with my CPA after the business became consistently profitable.

The tax treatment can be different because an S Corp is generally a pass-through entity. The corporation generally doesn't pay federal income tax at the corporate level in the same way a C Corporation does. Instead, income, deductions and other items generally pass through to shareholders and are reported on their individual returns.

But there are additional responsibilities.

If you're an owner actively working in the business, you can't simply take all the money as distributions and call it a tax saving. S Corp shareholders who provide services generally need to receive reasonable compensation for their services before taking non-wage distributions.

So the payroll side is a real consideration.

Why should I choose an S-corp? 

What are the benefits of an S-corp?