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Last Updated: 1/24/24
An S corporation (S corp) refers to a federal tax designation; it’s not an actual business type, so it’s not really a “corporation” in that sense. An S corporation refers to either a limited liability company (LLC) or a corporation that’s made an S corp election. For a corporation, S corp election is a way to avoid double taxation. For an LLC, it can be a way to save on self-employment taxes.
Not every LLC or corporation will qualify to be an S corp, though; they must meet the conditions of the Internal Revenue Service (IRS) first. We’ll outline those criteria and the steps you would need to take to file as an S corp, provided you decide that it’s a good move for your business.
You can learn more about S corps and how they affect your taxes later in this article.
For the IRS to accept your application for S corp election, you must meet the filing requirements of the Internal Revenue Code. Specifically, to qualify for S corporation status, an entity must:
If your business meets these conditions, you can apply for S corp election.
Are you a business owner — or wanting to become a business owner — in the Land of 10,000 Lakes? Starting a Minnesota S corp could be a way to save on taxes. But how do you form an S corp, and what exactly is an S corp? Read on for the answers.
To get a Minnesota S corp, you’ll need to create either an LLC or a C corporation (the default form of corporation) if you haven’t already done so. Then, you’ll file an election form with the IRS.
For more details on all of these steps and more, visit our “Start a Minnesota LLC” page.
If you’d rather form a Minnesota corporation, there are considerably more steps to follow, including filing Articles of Incorporation. See the instructions on our Minnesota corporation page.
When your LLC or C corporation formation is accepted 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 or 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 income tax at the federal level, just the individual owners. This is unlike the taxation for a C corp, in which profits are taxed at both the business and personal levels. But what about Minnesota income tax?
If you’ve elected to become an S corporation at the federal level, Minnesota automatically accepts you as an S corp for state income tax purposes. However, S corps, like most business entities in Minnesota, must pay a minimum fee, based on the sum of its Minnesota-sourced property, payroll, and sales. The good news is that (as of this writing in 2023), the fee is $0 if this sum is less than $960,000.
Whether your S corp is an LLC or a corporation, you’ll need to perform certain ongoing tasks to keep them in compliance. Minnesota requires LLCs and corporations to file an annual renewal, known in other states as an annual report. The filing provides the state government with up-to-date information about your business.
Corporations have additional ongoing compliance requirements. Every corporation doing business in the state must file an annual business activities report with the Department of Revenue.
Unless the bylaws or Articles of Incorporation say otherwise, corporations in Minnesota are also required to hold annual shareholder meetings at a time and place established in the bylaws. Keeping corporate records is another requirement for Minnesota corporations.
Note that these may not be the only ongoing requirements for your Minnesota S corporation. For example, you may have business licenses and/or permits that need to be renewed regularly.
While S corp status does come with benefits for some businesses, making this election might not be right for everyone. Carefully weigh the S corp’s strengths and weaknesses before deciding how you want to proceed. Consult a tax professional for guidance.
For a C corporation, filing as an S corp has these advantages:
One major drawback for traditional corporations is what’s known as “double taxation.” When the corporation makes money, the IRS taxes those profits on the business level on a corporation tax return. 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 company profits pass through to the owners of an S corp, so do the business’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 terms of 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. There’s an income threshold that, if exceeded, may reduce your QBI (see the IRS website for details).
S corporation status also has its downsides for C corps:
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. You also can’t have corporations or partnerships as shareholders.
Because of the extra restrictions on S corps, the IRS watches them more closely to see if they’re in compliance. Thus, your corporation is more likely to get audited.
Having an S corp election gives a different set of pros and cons for an LLC.
The pluses of filing as an S corp for an LLC aren’t exactly the same as they are for C corporations. An LLC without S corp election already has pass-through taxation, so the benefits of S corporation election for an LLC come from federal self-employment tax. We’ll explain more.
The members of a normal 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 you pay self-employment tax (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 corp status, they can be compensated by the LLC 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. (Note that 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 provision 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 $0.11 and avoid contributing anything to Social Security and Medicare.
So, what is “reasonable” to the IRS? 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.
S corp status can also have drawbacks for LLCs, though:
Having an LLC that files as an S corporation generally means additional 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 complicated, as well.
S corps have more qualifying conditions 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 such limitations.
Because of the “reasonable salary” restrictions, the IRS monitors LLCs filing as S corps more closely to ensure they’re not shortchanging Social Security and Medicare. That could mean a greater chance of being audited.
For additional information about how S corps are treated in Minnesota and other important tax info, see the Minnesota Department of Revenue website. The IRS website provides more information on the federal guidelines for S corporations. We recommend having a trusted tax professional by your side. They can guide you through legal and financial challenges so that you can stay in compliance while maximizing your tax savings.
First, form a C corporation or an LLC if you haven’t already done so. Then file Form 2553 with the IRS to get S corp election.
For the federal government, an S corp must file Form 1120S; this is an informational return since the S corp doesn’t pay federal income tax, just the business owners. For Minnesota, an S corporation would complete Form M8, S Corporation Return.
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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