File a Hawaii S Corp

Launching an S corporation in Hawaii can unlock tax savings for business owners, thanks to its unique tax status under Subchapter S of the Internal Revenue Code. This status avoids the double taxation faced by C corporations by allowing income to flow directly to shareholders. For Hawaii-based limited liability company (LLC) owners, electing S corp status can also mean substantial self-employment tax savings, by enabling a split between salary and distribution income, where only the former is subject to self-employment taxes. This guide will cover the key steps and benefits of converting your Hawaii business to an S corp, helping ensure you’re equipped to take full advantage of the potential tax efficiencies.

Hawaii S Corp Filing Requirements

For the IRS to accept your application for S corp election, you must meet the Internal Revenue Code filing requirements. Specifically, to qualify for S corporation status, an entity must:

• Be a domestic LLC or corporation
• Have no more than 100 shareholders or members (“shareholders” is the term for owners of a corporation, while “members” is the term for owners of an LLC)
• Have only allowable shareholders or members, which includes individuals, certain trusts, and estates. The shareholders/members may not be partnerships, corporations, or non-resident aliens. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations
• Only have one class of stock

If your business checks off all of these boxes, read on to learn about forming an S corp. 

Considerations for Hawaii S Corp Taxes

In an S corp, the business itself doesn’t usually pay income tax at the federal level, just the individual business owners’ level. But what about Hawaii state income taxes?

For state income tax purposes, Hawaii treats S corporations the same way the federal government does for federal income taxes. However, a Hawaii S corporation will still need to file a Hawaii S corporation income tax return (Form N-35).

How to Start a Hawaii S Corp

To get a Hawaii S corporation, you’ll need to create either a limited liability company (LLC) or a C corporation if you haven’t already done so. Once you have that in place, you’ll file an election form with the IRS.

Forming a Hawaii LLC

1. Name your Hawaii LLC
2. Appoint a registered agent in Hawaii
3. File Hawaii Articles of Organization
4. Create an operating agreement
5. Apply for an EIN
6. Apply for S Corp status with IRS Form 2553

For more details on these steps, see the instructions on our “Start a Hawaii LLC” page.

Forming a Corporation in Hawaii

1. Name your Hawaii corporation
2. Appoint Directors
3. Choose a Hawaii Registered Agent
4. File the Hawaii Articles of Incorporation
5. Create Corporate Bylaws
6. Draft a Shareholder Agreement
7. Issue shares of stock
8. Apply for Necessary Hawaii Business Permits or Licenses
9. File for an EIN and review tax requirements
10. Submit Your Corporation’s First Annual Report
11. Apply for S Corp status with IRS Form 2553

If you’d prefer to start a corporation instead, there are more steps to follow. We walk you through the process on our Hawaii corporation page.

File the form 2553 to apply for S corp election

When your LLC or C corporation formation is approved by the Hawaii Department of Commerce and Consumer Affairs Business Registration Division, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp status. 

The IRS requires that you complete and file your Form 2553: 

• Within 75 days of the formation of your LLC or C corporation, or no more than 75 days after the beginning of the tax year in which the election is to take effect

OR

• At any time during the tax year preceding the tax year the election is to take effect.

For LLCs wishing to file as an S corp: If your LLC is past the 75-day election deadline, you’ll also need to file Form 8832, Entity Classification Election, to elect to be taxed as a corporation. Then you would file both Form 8832 and Form 2553 together via USPS-certified mail. 

All of the shareholders/members are required to sign the consent statement portion of the form. For more information on when and how to file Form 2553, visit the IRS website.

Keeping Your S Corp Compliant

Whether your S corp is an LLC or a corporation, you’ll need to perform certain ongoing tasks to keep it in compliance. One of these is to regularly file a Hawaii annual report. This report is intended to keep the state informed about any changes to your business. The annual filing fees for C corporations and LLCs are the same, $12.50 to file a report online and $15 to file by mail. 

If your S corp was formed as a Hawaii corporation, you’ll need to keep records of the minutes of meetings, all actions taken by the shareholders and board of directors, and all actions taken by committees on behalf of the corporation. All Hawaii corporations are also required to hold annual shareholder meetings at a time and place established in the bylaws. 

This is not a complete list of all possible compliance requirements for your Hawaii S corp. For example, you may have business licenses and permits that need to be renewed regularly. Of course, you’ll also need to pay all state and local taxes.

Pros and Cons of S Corp for Hawaii LLCs and Corporations

S corporation election brings a different set of pros and cons for an LLC and Corporations.

Advantages of S Corp Status for LLCs

The advantages of filing as an S corp for an LLC differ from those for C corporations. A traditional LLC already has pass-through taxation, so the benefits of S corporation election for an LLC come from federal self-employment tax. We’ll explain.

Self-Employment Taxes

The members of a standard LLC are considered self-employed. They profit by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (Social Security and Medicare, which add up to about 15.3%) on all profits they receive from the LLC. This is double the taxes they’d pay when working for someone else because their employer would pay half of them.

Dividing Salary and Profits

But when the members elect S corporation status, they have the option to be compensated in two ways, by receiving their share of the profits and by being employed by the LLC. Once they do that, they only pay taxes for Social Security and Medicare on their salary and not the profits they receive. Depending on factors such as how profitable your company is, the savings could add up to a lot. (Of course, the members will still pay income and all other applicable taxes on their share of the profits and any other taxable income.) Money paid out as salary is a tax-deductible expense for the business. 

Reasonable Compensation

One important caveat to this is that the IRS expects LLC members to pay themselves a “reasonable salary” as an employee of the LLC. Otherwise, they could pay themself an annual salary of $0.15 and avoid contributing anything to Social Security and Medicare. 

So, what is “reasonable” compensation? While the terms aren’t 100% defined, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning for similar work.

Advantages of S Corp Status for C Corporations

For a C corporation, filing as an S corp has these benefits:

Pass-Through Taxation

“Double taxation” is a big disadvantage for traditional corporations. When the corporation makes money, the IRS taxes those profits on the business level. And when those profits are ‌distributed to the shareholders, they’re taxed a second time on the shareholders’ personal tax returns.

But when a C corporation qualifies to be an S corp, those profits are only taxed at the individual level. The business itself isn’t taxed on them. This is called “pass-through taxation.”

You can write off losses

The business’s profits pass through to the owners of an S corp, and so do the company’s losses. Unlike the shareholders of a C corporation, S corp owners can write off the business’s losses on their personal income statements. 

Qualified Business Income Deduction

Some S corp owners may be able to deduct up to 20% of their qualified business income under the 2017 Tax Cuts and Jobs Act. This deduction isn’t available to C corporation shareholders.

Qualified business income (QBI) is basically your share of the company’s profits, or, as the IRS puts it, “QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts.” The IRS website has a detailed explanation as to what is and is not included in QBI. There’s an income threshold that, if exceeded, may reduce your QBI (see the IRS website for details).  

Disadvantages of S Corp Status for LLCs

Having an LLC with S corp election isn’t all positives, though:

More Red Tape

Having an S corporation generally means more paperwork. If you don’t already have to do payroll for your business, being an owner-employee means that you’ll have to start. Your taxes will be more complex, as well.

Stricter Requirements 

S corps have more restrictions than a standard LLC. An S corp can have no more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. 

Extra IRS Scrutiny

The “reasonable salary” restrictions cause the IRS to monitor LLCs filing as S corps more closely. That could mean a greater chance of being audited.

Disadvantages of S Corp Status for C Corporations

S corp status also has its drawbacks for C corporations:

One Class of Stock

One way corporations attract investors is to offer preferred stock. However, the IRS doesn’t allow this for S corps.

Limited Number of Shareholders

An S corp can’t have more than 100 shareholders. A C corporation has no such restriction.

Limited Types of Shareholders

All S corp shareholders must be U.S. citizens, or certain trusts or estates. You also aren’t allowed to have corporations or partnerships as shareholders. 

More IRS Scrutiny

Because of the extra requirements for S corps, the IRS watches them more closely to see if they’re in compliance. So, your corporation is more likely to get audited.

State and Federal Resources

For additional information about how S corps are treated in Hawaii and other important tax info, see the Hawaii Department of Taxation website. At the federal level, the IRS website can also provide more information on the guidelines for S corporations. We recommend seeking out a trusted tax professional. They can guide you through legal and financial challenges so that you can stay in compliance while maximizing your tax savings.