File a Pennsylvania S Corp

Venturing into the establishment of an S corporation in Pennsylvania is a promising pathway for entrepreneurs looking to benefit from favorable tax treatment. An S corp, short for Subchapter S corporation, is a federal tax designation that allows businesses to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. This guide aims to unravel the complexities of initiating an S corp in the Keystone State, highlighting the unique advantages and statutory requirements that Pennsylvania offers.

For Pennsylvania business owners considering this structure, whether operating as a limited liability company (LLC) or a conventional corporation, electing S corp status can often lead to considerable savings on self-employment taxes and mitigate the burden of double taxation.

PA S Corp Filing Requirements

Before you begin, know that S corporations have some filing requirements and limitations to be aware of. Specifically, to qualify for S corporation election, an entity must:

• Be a domestic corporation or LLC
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales 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 one class of stock
• Have only allowable shareholders or members, which includes individuals, certain trusts, and estates. The shareholders may not be partnerships, corporations, or nonresident aliens. A nonresident alien is an alien who hasn’t passed the green card test or the substantial presence test.

If your business entity meets the above requirements, read on to learn how to start an S corp in Pennsylvania.

Forming an S Corp in PA

To create a Pennsylvania S corporation, 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.

Pennsylvania-Specific Considerations

In an S corporation, the business itself doesn’t usually pay federal income taxes, just the individual owners. But what about Pennsylvania income taxes?

Pennsylvania treats businesses that file as an S corp for federal income tax purposes the same way when it comes to income tax from the commonwealth. That is, the same pass-through taxation that applies to federal income taxes applies to commonwealth income taxes. For S corp owners, the Pennsylvania S corp tax rate is basically the Pennsylvania personal income tax rate. An S corporation is subject to Pennsylvania corporate net income tax only to the extent of its built-in gains. 

Some states require an S corporation to make a separate S corporation election at the state level, but Pennsylvania no longer requires that. If a company has a valid federal subchapter S corporation election, it will automatically become a Pennsylvania S corporation.

Pennsylvania also gives S corps the ability to opt-out of being taxed as a Pennsylvania S corp at the commonwealth level by filing Form REV-976. This may help some S corp owners with the limit imposed by the Tax Cuts and Jobs Act of 2017 on the amount of state and local taxes individuals can deduct for federal income tax purposes. To use this election, all of the S corp owners must sign the form. Once made, the election can’t be revoked for five years.

Start an S corp in Pennsylvania

For a limited liability company (LLC), filing as an S corporation could provide savings on self-employment taxes for the owners. For a C corporation (the default form of corporation), an S corporation can be a way to avoid double taxation. For more information about S corporations in general, see our “What Is an S Corporation?” page. 

S-Corp Election Steps for LLCs

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

• Step 1 – Choose a name
• Step 2 – Designate a Pennsylvania registered office
• Step 3 – File Pennsylvania Certificate of Organization
• 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 Pennsylvania Corporation formation guide.

• Step 1 – Name Your Corporation
• Step 2 – Appoint Directors
• Step 3 – Choose a Pennsylvania Registered Office
• Step 4 – File the Pennsylvania Articles of Incorporation and Docketing Statement
• Step 5 – Create Corporate Bylaws
• Step 6 – Draft a Shareholder Agreement
• Step 7 – Issue Shares of Stock
• Step 8 – Apply for Necessary Business Permits or Licenses
• Step 9 – File for an EIN and Review Tax Requirements
• Step 10 – Submit Your Corporation’s First Report
• Step 11 – Apply for S Corp status with IRS Form 2553

File the form for S corporation election

Complete and submit the form to apply for S corporation tax status. Once your LLC or C corporation formation is approved by the commonwealth, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corporation status. 

The Internal Revenue Service requires that you complete and file your Form 2553: 

• Within 75 days of forming your LLC or C 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.

There is a caveat for limited liability companies 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 file both Form 8832 and Form 2553 together via USPS-certified mail. 

Every one of the members or shareholders must sign the consent statement portion of the form. For more information on how to file Form 2553, visit the IRS website.

PA S Corp: Pros and Cons

While S corporation classification does come with a number of benefits for some businesses, making this election might not be right for every company. Sit down with an experienced tax professional and carefully weigh the various pros and cons before deciding how you want to move forward. 

S Corporation Pennsylvania: Advantages for LLCs

The advantages of filing as an S corporation for an LLC aren’t the same as they are for C corporations. First, let’s look at the advantages for LLCs.

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

Explaining Self-Employment Taxes

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, meaning that they’re self-employed.

Being self-employed means you pay self-employment taxes (Social Security and Medicare, which add up to about 15.3%) on all the profits you receive from the LLC. This is more than the taxes you’d pay when working for someone else because your employer would pay part of them.

Dividing Profits and Salary

But when the members make an S corporation election, 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.) Money paid out as salary is a tax-deductible expense for the business. 

Reasonable Compensation

One important stipulation to this is that the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. If they didn’t, you could pay yourself an annual salary of $8 and avoid contributing anything to Social Security or Medicare. 

So, how is “reasonable compensation” defined by the IRS? 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.” While the terms aren’t clearly defined, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning.

If the Internal Revenue Service determines that whatever salary you’re paying yourself isn’t reasonable, it has the authority to reclassify your non-wage distributions (which aren’t subject to employment taxes) to wages (which are subject to employment taxes). Various court cases have supported the IRS’s right to do this.

PA S Corp: Advantages for C Corporations

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

Pass-Through Taxation

One 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 shareholders as dividends, they’re taxed a second time on the shareholders’ personal tax returns.

But when a corporation qualifies to be an S corporation, those profits are only taxed at the individual shareholder level. The business 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 choose to be taxed as a corporation.

However, since the 2017 Tax Cuts and Jobs Act, the corporate tax rate has been lowered to a flat 21%. Thus, the disadvantages of double taxation aren’t as severe now as they were. Read the in-depth pass-through taxation definition for more.

Writing Off Losses

Just as business profits pass through to the owners of an S corporation, so do the losses. Unlike the shareholders of a C corp, S corporation shareholders 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 its early years. However, make sure you’re aware of and understand ​​the IRS’s shareholder loss limitations.

Qualified Business Income Deduction

Under the 2017 Tax Cuts and Jobs Act, some S corporation owners may be able to deduct up to 20% of their qualified business income. This deduction isn’t available to C corp 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).  

Disadvantages of S Corporation Status for C Corporations

S corporation election also has the following minuses:

Limited Number of Shareholders

As mentioned, an S corporation can’t have more than 100 corporation shareholders, while a C corporation doesn’t have that restriction. This limitation could be 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 become a problem if you want to expand internationally. You also can’t have partnerships or corporations as shareholders. Standard corporations don’t have these limitations.

Only One Class of Stock

A common way corporations attract investors is to offer preferred stock. That’s okay for C corporations, but the IRS doesn’t allow it for S corporations.

More IRS Scrutiny

As with LLCs, the extra restrictions S corps have often cause the IRS to watch them more closely to see if they’re in compliance. In other words, your corporation has a higher chance of being audited.

Again, it’s important to have tax guidance about your specific situation from a qualified tax professional. An accountant with S corporation experience should be able to make sure you stay in compliance with the IRS. They may also be able to help you find additional ways to lower your tax bill.

Disadvantages of S corporation Status for LLCs

Having an LLC with S corporation status can also have some drawbacks over a regular LLC:

Stricter Requirements 

S corporations have more qualifications than a standard LLC or corporation (as we listed above). Pennsylvania S corp filing requirements say that you can have no more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. A standard LLC doesn’t have these limitations.

More Scrutiny from the IRS

Because of the above restrictions and the requirements about paying yourself a “reasonable salary,” the IRS usually monitors LLCs filing as S corps more closely. That could mean a greater chance of being audited, even if you follow the law to the letter. In fact, small business owners in an S corporation may want to observe some of the same formalities that corporations do (such as extensive record keeping), even if they’re not legally required to. It’s not necessary to appoint corporate officers or write corporate bylaws, but keeping something similar to a corporate records book could be useful if the business is audited.

More Bookkeeping and Accounting

Having an LLC with an 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 do so. Your taxes will be more complex, too.

With these added complications, it’s possible that you’ll have higher administrative costs because you may need to pay for an accountant, bookkeeper, and/or a payroll service or software.

S Corp Tax Calculator

The S Corporation tax calculator below lets you choose how much to withdraw from your business each year, and how much of it you will take as salary (with the rest being taken as a distribution.) It will then show you how much money you can save in taxes.

Disclaimer: The savings estimate provided by this tool is for informational purposes only and should not be considered financial, tax, or legal advice. Actual savings may vary depending on individual circumstances and other factors. We recommend consulting with a qualified tax or legal professional before making any decisions regarding your business entity. ZenBusiness, Inc. is not responsible for any actions taken based on the information provided by this tool. Use of this tool does not establish any client relationship with ZenBusiness, Inc.

Get help establishing a Pennsylvania LLC with S corp tax election

Forming an S corporation or any business can be complicated, but we’re here to make it as simple for you as possible.

When you’re ready to make your move, we can help you form a Pennsylvania LLC with an S corporation designation and provide you with valuable support from our team of business experts.

Branching out of Pennsylvania? Check out: File a Vermont S Corp