Seriously, what the hell is an S-Corp? I get asked this all the time. This is one of those topics that the internet is terrible for. There’s so much misconception about what an S-Corp is and when it’s actually useful.
First and foremost, in North Carolina, an S-Corp is not a distinct legal entity. Both corporations and LLCs can be taxed as S-Corps. It’s merely a tax election.
What is an S-Corp?
S Corp, which is short for Subchapter S Corporation is a tax election corporations or LLCs can make. Essentially, the entity elects to have their income treated as partnership, but they entity may also give out dividends that are not subject to the self employment taxes. The entity may only give out those dividends to owners once those owners have been paid a “reasonable salary” for the work they’ve done. That’s the hardest criteria of this tax election because defining a reasonable salary is incredibly vague.
In order to elect to be taxed as an S-Corp, you cannot fall into certain limitations:
- Cannot have more than 100 shareholders.
- No corporate, LLC, partnership, or other business entity shareholders.
- All shareholders must be US citizens or residents.
- Only one class of stock.
- Dividends must be given out in proportion to ownership.
When to Use It
Typically, you’re going to want this tax election if (1) you’re making above what you would make doing the same thing for someone else, (2) you aren’t limited by your ownership, and (3) the added administrative cost won’t make it more costly than you benefit.
I personally use, and recommend others to use, a payroll company to handle the additional administrative burden. You should expect between $40 and $400 per month in additional cost. To make it worthwhile, you should only elect the S-Corp if you’re going to save more than that in taxes.