If you’re an entrepreneur in the Garden State, you may have heard that starting a New Jersey S corporation could be a way to save on taxes. But what exactly is an S corp, and how do you go about getting one? We’ll cover that and more in this article.
Despite how it might sound, an S corporation (S corp) isn’t a type of business structure. It’s actually a federal tax classification that either a limited liability company (LLC) or a corporation can apply for with the Internal Revenue Service (IRS), provided it meets the right criteria. We’ll explain what the qualifications are and the steps you would need to take to file as an S corp if you decide that it’s right for your business.
We’ll explain more about S corps and how they affect your taxes later in this article.
If you want the IRS to accept your application for S corporation election, you must meet the filing requirements of the Internal Revenue Code. To qualify for S corporation tax status, your business must:
If your business checks all the boxes above, you can apply for an S corporation election.
Starting a New Jersey S corporation requires you first to have either a limited liability company (LLC) or a C corporation, so you’ll need to create one if you haven’t already done so. Then, you’ll file an election form with the IRS.
To form an LLC in New Jersey, first pick a distinct name for your business that’s unique to New Jersey while also following the state’s naming guidelines. From there, you’ll need a registered agent to accept service of process. Next, file your Certificate of Formation with the New Jersey Division of Revenue and Enterprise Services; this step makes your LLC official.
Write 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 New Jersey LLC” page.
If you’d instead prefer to form a corporation in New Jersey, see the instructions on our New Jersey corporation page.
When your LLC or corporation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corporation status.
The IRS requires that you complete and file your Form 2553:
One note for LLCs wanting 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.
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.
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In an S corp, the business itself doesn’t usually pay federal income taxes, just the individual owners. But what about New Jersey state income taxes?
Until recently (December 2022), New Jersey required S corporations to make a separate S corporation election at the state level to be treated as an S corporation for state income tax purposes. However, that law has been repealed, so New Jersey will automatically treat an S corporation the same way it’s treated for federal income tax purposes.
Whether your S corp is an LLC or a corporation, you’ll need to perform certain ongoing tasks to keep them in compliance. One of these is to regularly file a New Jersey annual report. This report is intended to keep the state informed about any changes to your business. There’s a $75 filing fee for the report, and it’s due every year on the last day of the month in which you completed your business formation.
Corporations in New Jersey are also required to hold annual shareholder meetings at a time and place established in the bylaws. Keeping corporate records, including the minutes of meetings, is another requirement for New Jersey corporations.
Note that these may not be the only ongoing requirements for your S corp. For example, you may have business licenses that need to be renewed regularly.
While S corp status does come with tax advantages for some businesses, making this election might not benefit everyone. Carefully weigh the pluses and minuses before committing to become an S corp. Consult a tax professional about whether the S corportion election would be best for your business.
The perks of filing as an S corp for an LLC aren’t exactly the same as they are for C corporations. An LLC without S corporation 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.
The members of a usual 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 pays half of them.
But when the members elect S corp status, they can receive money from the business in two ways, by getting 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 tax on 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 your LLC. Otherwise, you could pay yourself an annual salary of $0.08 and avoid contributing anything to Social Security or Medicare.
But then what’s considered “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 S corp status isn’t all positive for LLCs, though:
Because of the “reasonable salary” restrictions, the IRS monitors LLCs filing as S corps more closely. That could mean a greater chance of being audited.
S corps must meet more 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 these limitations.
Having an LLC with S corporation election 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.
Having S corp election means a different set of pros and cons for a corporation.
If you have a C corporation (the default form of corporation), filing as an S corp has these advantages:
One big downside to corporations is “double taxation.” 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 becomes an S corp, those profits are only taxed at the individual level. The business itself isn’t taxed on them, so you’re spared the corporation business tax. This is called “pass-through taxation.”
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 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 more details on 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 more).
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.
S corp status isn’t all positives for C corps:
One way corporations attract investors is to offer preferred stock, but the IRS doesn’t allow this for S corps.
An S corp can have no more than 100 shareholders, while a C corporation has no 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.
The extra limitations S corps have mean that the IRS watches them more closely to see if they’re in compliance. Thus, your corporation is more likely to get audited.
Yes. New Jersey will automatically treat an S corp the same way for state income tax purposes as it’s treated for federal income tax purposes.
First, form an LLC or a corporation, if you haven’t already done so. Then file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp status.
In New Jersey, state income taxes are paid by the individual business owners, not the business itself. This is unlike a traditional corporation, where profits would be taxed at both the business and individual levels. Other taxes may apply to the S corp itself.
A C corporation is a legal business entity, but an S corp is just a tax status that a corporation or an LLC can adopt.
New Jersey will automatically treat an S corp the same way for state income tax purposes as it’s treated for federal tax purposes; that is, profits are only taxed at the individual owner level, not the business level.
Our S corp service can help you start an LLC with S corp election so that you can take advantage of any tax benefits it offers. Plus, we offer other services to help you run and grow your business and stay in compliance. Get started today and make your dream business a reality.
For more information about how S corps and other pass-through entities are treated in New Jersey and other important tax information, see the New Jersey Department of Treasury website. The IRS website can also provide more information on the federal guidelines for S corporations. Most of all, we recommend having a qualified New Jersey tax advisor. They can help you through legal and financial challenges, helping you get the most benefits from your S corporation.
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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