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Last Updated: 1/18/24
An S corporation (S corp) isn’t a business structure like an actual corporation. It’s a special tax status that an LLC or C corporation (the default form of corporation) can make by applying to the Internal Revenue Service (IRS) and meeting the requirements. We’ll explain those criteria and the steps you would need to take to file as an S corp if you decide that it’s right for you and your business.
You can get a more detailed exploration of S corps here.
Before you get started on your application for S corp election, know that you must meet the filing requirements of the Internal Revenue Code. Specifically, to qualify for S corporation status, an entity must:
If your business entity falls within these parameters, read on to learn more about S corps.
If you’re thinking of launching your business enterprise in the Grand Canyon State, you may want to consider an Arizona S corp. An S corporation can be a way for limited liability companies (LLCs) and corporations to save on taxes. This article will explore the pros and cons of S corporations and how to set up one in Arizona.
To start an Arizona S corporation, you’ll need to have either a limited liability company (LLC) or a C corporation if you don’t already. Then, you’ll file an election form with the IRS.
For more details on these steps, visit our “Start an Arizona LLC” page.
For more details on these steps, visit our “Start an Arizona Corporation” page.
When your LLC or C corporation formation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp election.
The IRS requires that you complete and file your Form 2553:
One caveat 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.
Note that all of the shareholders/members must sign the consent statement portion of the form. For more information on when and how to file Form 2553, visit the IRS website.
In an S corp, the business itself doesn’t usually pay federal income taxes. But what about Arizona income taxes?
Arizona will treat an S corp the same way the federal government does; you don’t need to make a separate election for the state. However, corporations taxed as S corps must file Arizona Form 120S at tax time.
If your S corp is a corporation, you must file an annual report and pay a $45 fee every year. LLCs in Arizona aren’t required to file an annual report or pay its fee.
Corporations in Arizona are required to hold annual shareholder meetings at a time and place established in the bylaws. Shareholders must be notified at least 10 days prior to the meeting.
Keeping corporate records is also a requirement for Arizona corporations. You’ll need to record the minutes of meetings and maintain a record of all actions taken by the board of directors and the shareholders outside of the meetings, as well as actions taken by committees appointed by the committees.
While S corp status does come with a number of benefits for some businesses, making this election might not be right for every company. Carefully weigh the pros and cons before deciding how you want to proceed. Consult a qualified accountant about whether the S corp election would be best for your business.
The advantages of filing as an S corp for an LLC aren’t quite the same as they are for C corporations. A traditional LLC already has pass-through taxation (more on that later), so the benefits of S corporation election for an LLC come from federal self-employment tax. We’ll explain.
The members of a regular LLC are considered self-employed. They’re compensated 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.
But when the members get S corp status, they can 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 substantial amount. (Of course, the members will still pay income and all other applicable taxes on their share of the profits and any other taxable income.) Also, money paid out as salary is a tax-deductible expense for the business.
The IRS does impose an important condition, though: You must pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $0.04 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.
LLCs with S corp status can also have drawbacks, though:
S corps have more qualifying conditions than a standard LLC. An S corp can have no more than 100 members, and none can be partnerships, corporations, or non-resident aliens. A traditional LLC doesn’t have these limitations.
Because of the “reasonable salary” restriction, the IRS looks at LLCs filing as S corps more closely. That could mean a greater chance of being audited.
Having an LLC that files as 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.
If you have a C corporation, filing as an S corp has these advantages:
One big disadvantage for traditional corporations is “double taxation.” When the corporation makes a profit, the IRS taxes that money 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.”
Just as business profits pass through to the owners of an S corp, 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.
Under the 2017 Tax Cuts and Jobs Act, some S corp owners may be able to deduct up to 20% of their qualified business income. 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. If you exceed your income threshold, it may reduce your QBI (see the IRS website for details).
S corp status also has its downsides for C corps:
As we said, an S corp is limited to 100 shareholders, while a C corporation has no such restriction.
All S corp shareholders must be U.S. citizens, or certain trusts or estates. That might limit your ability to expand internationally. You also can’t have corporations or partnerships as shareholders.
One way corporations attract investors is to offer preferred stock, but the IRS doesn’t allow this for S corps.
Because of the extra limitations S corps have, the IRS watches them more closely to see if they’re in compliance. Thus, your corporation is more likely to get audited.
For more information about how S corps and other pass-through entities are treated in Arizona and other important tax information, see the Arizona Department of Revenue website. The IRS website can also provide more information on the federal guidelines for S corporations. We recommend having a qualified Arizona tax professional. They can help you through legal and financial challenges, helping ensure compliance and tax efficiency for your new S corp.
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Yes. For state tax purposes, Arizona treats a business with S corp election the same way the federal government does. The S corp itself doesn’t pay state income tax, just the members or shareholders.
No, Arizona doesn’t have a tax specific to S corps. Your S corp would pay the same taxes an LLC or corporation would.
First, you’ll need to form an LLC or C corporation, if you haven’t already done so. To elect S corp status, you need to file Form 2553, Election by a Small Business Corporation, with the IRS.
You will need to have an Arizona corporation or LLC and meet the conditions listed above in “Arizona S Corp Filing Requirements.” From there, you would file Form 2553, Election by a Small Business Corporation, with the IRS.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Arizona Business Resources
How to File an S Corp in Your State
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