Being a small business owner comes with risks and rewards. One of those risks is handling the unknowns of business taxation. But how can you save on federal taxes? Whether your business entity is a corporation or a limited liability company (LLC), a DC S corp might help you save on your federal tax obligations.
You should understand that an S corp is not a business structure. Rather, it’s a federal tax classification that either an LLC or a corporation can apply for with the Internal Revenue Service (IRS) if it meets the criteria. We’ll outline those criteria and the steps you would need to take to file as an S corp if you decide that it’s right for your business.
For more detailed information about S corps, see our “What is an S Corporation?” page.
There are a few S corp filing requirements and limitations you should be aware of before you begin this process. Specifically, to qualify for S corporation status, an entity must:
Not all business entities are eligible for S corp classification. However, if your business entity meets these requirements, you can apply for an S corp election.
To create a District of Columbia S corporation, you’ll need to create either a limited liability company (LLC) or a C corporation if you haven’t already done so. Then, you’ll file an election form with the IRS.
To form an LLC in DC, first choose a name for your business that’s unique to the District of Columbia and follows DC’s naming guidelines. From there, designate a registered agent and file your Articles of Organization. Draft an operating agreement for your LLC to spell out how it will be run and organized. Finally, get an employer identification number (EIN) from the IRS. For more details on these steps, visit our “Start a District of Columbia LLC” page.
If you’d rather form a District of Columbia corporation, follow the instructions on our DC incorporation page.
Once 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 status.
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.
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In an S corp, the business itself doesn’t usually pay federal income taxes. But what about DC income taxes?
The District of Columbia doesn’t recognize S corp elections. You can still be an S corp on the federal level, but for DC tax purposes, the District will treat you like a C corporation. This means you’ll be responsible for all the DC taxes your company would pay if it were a C corporation.
Corporations must also pay a minimum tax of $250 if DC gross receipts are $1 million or less. There’s a $1000 minimum tax if DC gross receipts are more than $1 million.
Regardless of S corp status, an LLC or a corporation must file a biennial report and pay an accompanying fee of $300 every two years. The purpose of the report is to update the DC government as to the basic information about your company. The report is due on April 1 of the year following the year in which the LLC or corporation was formed and every two years thereafter.
If you began your S corporation as a C corp, you’ll need to follow all the requirements for a DC corporation. This includes holding an annual shareholder meeting at a time established in the bylaws or Articles of Incorporation (§ 29–405.01).
While S corp classification does come with a number of benefits for some businesses, making this election might not be right for all companies. So, be sure to carefully weigh the various pros and cons before deciding how you want to move forward. Consult a tax professional 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 exactly the same as they are for C corporations. A traditional LLC already has pass-through taxation, so the benefits of S corporation election for an LLC have to do with federal self-employment tax. We’ll explain.
The members of a standard 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 more than the taxes they’d pay when working for someone else because their employer would pay half of them.
But when the members elect S corp status, they can 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. (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.
One caveat to this 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 $0.01 and avoid contributing anything to Social Security and Medicare.
So, what is “reasonable compensation”? While the terms aren’t completely 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 have some drawbacks:
S corps have more qualifications 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. A traditional LLC doesn’t have these limitations.
Because of the above restrictions and the requirements about paying yourself a “reasonable salary,” the IRS monitors 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 do so. Your taxes will be more complex, as well.
If you have a C corporation (the default form of corporation), filing as an S corp does have its advantages:
One big disadvantage for traditional corporations is “double taxation.” When the corporation makes money, the IRS taxes those profits on the corporate 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 losses. Unlike the shareholders of a C corporation, S corp owners can write off the company’s losses on their personal income statements.
Under the 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. There’s an income threshold that, if exceeded, 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 can’t have more than 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 could limit your ability to expand internationally. You also can’t have partnerships or corporations as shareholders.
One way corporations attract investors is to offer preferred stock. The IRS doesn’t allow this for S corps.
Because of the extra restrictions 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.
The District of Columbia doesn’t recognize a business’s S corp election, meaning that, for DC tax purposes, the District will treat an S corporation no differently than a C corporation. For federal tax purposes, the S corp will still be treated as a pass-through entity like a sole proprietorship or general partnership.
First, you’ll need to set up either an LLC or a C corporation. Then you’ll need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp status.
DC S corps pay the same rate for corporate taxes as DC C corps, which, as of this writing, is 8.25%
An LLC is a formal business structure, whereas an S corp is a federal tax designation that an LLC or a corporation can elect if it meets the criteria.
While there may not be D.C.-specific resources for S corp guidance, the IRS website can provide more information on the federal guidelines of S corporations. We also recommend having a trusted tax advisor or accountant. They can help you through legal and financial challenges, helping ensure compliance and tax efficiency.
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.
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