Start a Delaware S corp

Requirements and Limitations of S Corporations

Before you decide on an S corporation in Delaware, you need to be aware of the S corporation filing requirements. Not every LLC or corporation will qualify. To get S corp tax status from the IRS, your business must:

• Be a domestic corporation or LLC
• Not be an ineligible corporation, such as an insurance company, a domestic international sales corporation, or certain financial institutions 
• Have only one class of stock (this applies to corporations)
• 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.

If your business fits these requirements, keep reading to learn about forming an S corporation in Delaware.

Filing as an S Corp in Delaware

To set up a Delaware S corp, you’ll first need to create either an LLC or a C corporation if you haven’t already done so. Then, you’ll file an election form with the IRS.

If you’re ready to learn about filing as an S corporation in Delaware, we’ll walk you through it step by step. First, we’ll show you how to form an LLC in Delaware. If you’d prefer to form a Delaware corporation instead, follow the instructions on our Delaware corporation page. Then, in Step 6, we’ll explain how to file for S corp tax status as either an LLC or corporation.

Delaware S Corp Considerations

When an LLC or C corp elects to be taxed as an S corp for federal income taxes, Delaware, like most states, applies state income tax in the same way. That is, the business itself doesn’t pay federal or state income tax on the profits. The profits are usually taxed only on the personal income tax return of the individual owner or owners.

Even so, Delaware does require every S corp that derives income from within the state to file Form 1100S, S Corporation Reconciliation and Shareholders Information Return.

For some LLC owners, forming an S corp can lower what they would pay in self-employment taxes. For C corporations (the default form of corporation), it can be a way to avoid double taxation. Our “What Is an S Corporation?” page explains more about the pros and cons of S corp tax status.

If you’re thinking of setting up an S corp, Delaware may be the place to do it. The First State has a long-established reputation for being friendly to businesses, especially Delaware corporations.

S-Corp Election Steps for LLCs

For detailed formation steps, see our Delaware LLC formation guide.

• Step 1 – Choose a name
• Step 2 – Choose a registered agent
• Step 3 – File your Delaware Certificate of Formation
• Step 4 – Create an operating agreement
• Step 5 – Apply for an EIN
• Step 6 – Apply for S Corp status with IRS Form 2553

S-Corp Election Steps for Corporations

For detailed formation steps, see our Delaware Corporation formation guide.

• Step 1 – Decide on a business name
• Step 2 – Choose a Delaware Registered Agent
• Step 3 – File the Delaware Certificate of Incorporation
• Step 4 – Hold the first meeting and choose directors
• Step 5 – Create Delaware corporate bylaws and a shareholder agreement
• Step 6 – Issue shares of stock for your Delaware corporation
• Step 7 – Obtain an EIN
• Step 8 – Open a corporate bank account for your Delaware corporation
• Step 9 – Apply for S Corp status with IRS Form 2553

File Form 2553 to Turn Business into an S Corporation

Submit the form to apply for S corporation status. Once your LLC or corporation formation is approved by the state, you’ll need to file Form 2553, Election by a Small Business Corporation, to get S corporation status. 

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

• Within 75 days of the formation of your LLC or 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.

One additional note for LLCs wishing to file as an S corporation: 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. 

For more information on when and how to file Form 2553, visit the IRS website.

Pros and Cons of Filing as an S Corporation

While S corporation classification does come with benefits for some businesses, making this election might not be right for everyone. Be sure to carefully weigh the various pros and cons before deciding how you want to proceed. Consult a tax professional about whether the S corp election would be best for your company.

Advantages for LLCs with S Corporation Status

The benefits of filing as an S corporation for an LLC differ from the benefits for a C corporation. Let’s look at the advantages for LLCs first.

A traditional LLC already has pass-through taxation, so the benefits of S corp election for an LLC have to do with self-employment taxes. This takes some explanation, but for certain LLCs, it could save a lot in taxes.

Self-Employment Taxes Explained

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

Dividing Salary and Profits

But electing S corporation status allows the members to be compensated in two ways, by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay Social Security and Medicare taxes 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. (To be clear, the members will still pay income and all other applicable taxes on their share of the profits.) 

Reasonable Compensation

One caveat to this arrangement is that the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $2 and contribute almost nothing to Social Security and Medicare. 

So, what’s considered “reasonable compensation”? The instructions on Form 1120-S read, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.” Essentially, the IRS considers “reasonable” to be something similar to what others in your field are earning for the same job.

If the IRS decides that your salary isn’t reasonable, it has the authority to reclassify your non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). Several court cases have supported the IRS’s right to do this.

Advantages of S Corp Status for Delaware C Corporations

If you have a C corporation (the default form of corporation), filing as an S corp has the following benefits:

Pass-Through Taxation

A major disadvantage for traditional corporations is “double taxation.” When the corporation makes money, the IRS taxes those profits on the corporate level. But when those profits are ‌distributed to the individual owners (shareholders) as dividends, they’re taxed a second time because the shareholders pay personal income tax on their share of the profits. In other words, the profits are taxed twice.

But when a corporation qualifies to be an S corp, the corporate income tax is bypassed; profits are taxed only at the individual level. The corporation itself isn’t taxed on them. This is called “pass-through taxation,” and it’s how business entities like sole proprietorships and general partnerships are taxed. LLCs are also taxed this way unless they opt to be taxed as a corporation.

We need to add here that, since the 2017 Tax Cuts and Jobs Act, the corporate tax rate has been lowered to a flat 21%. So, the disadvantages of double taxation aren’t as severe now as they were. 

Writing Off Losses

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

This can help offset their income from other sources and can be helpful if the corporation loses money in the initial years. Still, make sure you’re aware of ​​the IRS’s shareholder loss limitations.

Qualified Business Income Deduction

Under the Tax Cuts and Jobs Act of 2017, 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 essentially 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 more 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 for LLCs with S Corporation Status

Owning an LLC with S corporation status can also have some drawbacks over a traditional LLC:

More Filing Requirements 

As we listed above, S corps must adhere to more regulations than a standard LLC or corporation. An S corp can have no more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. A traditional LLC doesn’t have these limitations.

More IRS Scrutiny

Due to the above restrictions and the requirements about paying yourself a “reasonable salary,” the IRS tends to scrutinize LLCs with S corporation tax status more closely. That could mean a greater chance of being audited, even if you follow the law to the letter. In fact, LLCs with S corporation status may want to observe many of the same formalities that corporations do (such as regular meetings and extensive record keeping), even if they’re not legally required to.

Additional Accounting and Bookkeeping

Having an LLC that files as an S corporation usually 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 do so. Your taxes will be more complicated, too.

With these added complications, you’re likely to have higher administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.

Disadvantages of S Corp Status for C Corporations

S corporation status also has its pitfalls for Delaware corporations:

Limited Number of Shareholders

As mentioned above, an S corp can’t have more than 100 shareholders, while a C corporation has no such restriction. That limitation could become an issue later if the corporation expands and goes public.

Limited Types of Shareholders

All S corp shareholders must be U.S. citizens, or certain trusts or estates. That could limit the corporation’s ability to expand internationally. Also, the corporation can’t have partnerships or corporations as shareholders. C corporations don’t have these limitations.

One Class of Stock

Corporations sometimes use preferred stock to attract investors, but the IRS doesn’t allow this for S corps.

Closer IRS Scrutiny

Because of the restrictions S corps have, the IRS watches them more closely to see if they’re in compliance. In other words, your corporation is more likely to get audited.

We want to stress again how important it is to have tax guidance about your specific situation from a qualified tax professional. An accountant with S corp experience should be able to make sure you stay in compliance with the IRS, and they also may be able to help you find additional tax savings.