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Last Updated: 1/24/24
It’s important to understand first what an S corporation (S corp) is and whom it’s intended for. An S corp isn’t a business in and of itself. Instead, it’s a tax election that a limited liability company (LLC) or a C corporation (the default form of corporation) can make, provided it meets all the criteria. For a corporation, S corp election is a way to avoid the double taxation that most corporations face. For an LLC, it could be a way to save on self-employment taxes for some businesses.
Not every business will qualify to be an S corp, though; they must meet the conditions of the Internal Revenue Service (IRS) first. We’ll list those criteria and the steps you would need to take to file as an S corp, provided you consider it to be a wise move for your business.
Later in this article, you can also learn more about the pros and cons of S corps.
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:
If your business checks off all of these boxes, read on to learn about forming an 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.
For more details on these steps, see the instructions on our “Start a Hawaii LLC” page.
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.
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:
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.
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).
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.
While S corp status does come with some enticing benefits for some businesses, making this election might not be right for everyone. Consider the different angles before deciding how you want to proceed. Consult a tax professional about whether the S corp election would be best for your company.
For a C corporation, filing as an S corp has these benefits:
“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.”
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.
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).
S corp status also has its drawbacks for C corporations:
One way corporations attract investors is to offer preferred stock. However, the IRS doesn’t allow this for S corps.
An S corp can’t have more than 100 shareholders. A C corporation has no such restriction.
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.
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.
S corporation election brings a different set of pros and cons for an LLC.
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.
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.
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.
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.
Having an LLC with S corp election isn’t all positives, though:
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.
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.
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.
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.
If your company is recognized as an S corp at the federal level, you don’t need to make a separate election at the state level. You will have the same pass-through taxation for state income tax purposes as you do for federal income taxes.
No, Hawaii does not accept federal extensions for S corporations.
Hawaii has no tax that applies exclusively to S corps. Other taxes will apply, however.
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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