Are you thinking about starting an S corp? South Carolina may be the place to do it. But before you get started, you’ll probably want to know what an S corp is, what tax benefits it can offer, and how to start one. This article is here to guide you through the process.
The term S corporation (“S corp” for short) causes confusion for some people because it’s not an actual corporation. It’s a federal tax classification that either a limited liability company (LLC) or a corporation can apply for with the Internal Revenue Service (IRS) if it meets the right criteria. We’ll list those criteria and the steps you would need to take to file as an S corp if you decide that it’s right for you and your business.
You can learn more about S corps on our dedicated S corporation page.
An S corp has filing requirements you must meet for the IRS to accept your application. Specifically, to qualify for S corporation status, an entity must:
If your business entity falls within the above parameters, you can apply for an S corp election.
To get a South Carolina S corporation, you must first have a business structure, either a limited liability company (LLC) or a C corporation (the default form of corporation). Then, you’ll file an election form with the IRS.
To form an LLC in South Carolina, first decide on a name for your business that’s unique to South Carolina and follows the state’s naming guidelines. From there, designate a South Carolina registered agent and file your Articles of Organization. Write an operating agreement for your LLC to spell out how it will be organized and operated. Finally, get an employer identification number (EIN) from the IRS. For more details on these steps, visit our “Start a South Carolina LLC” page.
If you’d rather form a South Carolina corporation, that process involves more steps. Follow the instructions on our South Carolina corporation page for guidance.
When your LLC or 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:
For LLCs wishing to file as an S corp, take note: 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 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 South Carolina income taxes?
South Carolina does recognize federal S corp election, so an S corp in South Carolina won’t pay corporate income tax to the state. But S corps are still subject to the South Carolina corporate license fee, which is 0.1% of capital and paid-in-surplus, plus $15. There’s a minimum fee of $25.
South Carolina S corporations must also file Form SC1120S with the state every year.
All South Carolina S corporations must file an annual report as part of their taxes. An annual report is intended to update the state on the basic information about your business. In many states, annual reports represent a function of the office of the Secretary of State. South Carolina is rather unusual in that the annual report is part of your corporate tax return, Schedule D of Form SC1120S for an S corporation.
Corporations in South Carolina 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 and all actions of the directors, is another requirement for South Carolina corporations.
Note that these may not be the only ongoing requirements for your South Carolina S corp. For example, you may have business licenses and permits that need to be renewed regularly, and you’ll likely need to keep up with estimated tax by making quarterly estimated tax payments.
While S corp election does come with a number of tax benefits for some businesses, making this election might not be right for everyone. Be sure to weigh the pros and cons before making a decision, and consult a tax professional about whether the S corp election would be best for your business.
If you have a C corporation, filing as an S corp has the following advantages:
One major disadvantage for C 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.
However, making a C corporation into an S corporation allows those profits to be taxed only at the individual level. The business itself isn’t taxed on them. This is called “pass-through taxation.”
With 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 portion 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).
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 business’s losses on their personal income statements.
S corp status isn’t without its downsides for C corps:
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 corporations or partnerships as shareholders.
As we said earlier, an S corp can’t have more than 100 shareholders, but a C corporation has no such restriction.
Corporations can sometimes attract investors by offering preferred stock, but the IRS doesn’t allow this for S corps.
Because of the extra limitations S corps have, the IRS watches them more closely to see if they’re in compliance. And so, your corporation is more likely to get audited.
S corp election comes with a different set of pros and cons for an LLC.
The advantages of filing as an S corp for an LLC aren’t exactly the same as they are for C corporations. A normal 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’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 company. This is double the taxes they’d pay when working for someone else because their employer would pay half of them.
When an LLC becomes an S corp, the members can 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 tax 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.
An important 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 $0.09 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.
S corp status for LLCs can have drawbacks, though:
Because of the “reasonable salary” restrictions, the IRS monitors LLCs filing as S corps more closely. That might mean a greater chance of being audited.
S corps have more qualifying conditions than an LLC without S corp election. An S corp can have no more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. A normal LLC doesn’t have these limitations.
If you love paperwork, there’s good news: Having an LLC that files as an S corporation generally means more of it. 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.
To start an LLC with S corporation election, follow these steps:
If you prefer to have a C corporation with S corp election, follow the instructions for forming a corporation and then file Form 2553.
Yes, South Carolina recognizes federal S corp election, meaning that the business itself won’t pay state income tax, just the individual business owners.
Filing for an S corp with the federal government is free. However, if you don’t yet have an LLC or corporation, you’ll need to first form one, and there are fees for that. The filing fee for a South Carolina LLC is $125 and the fee for a corporation is $350.
An LLC is a legal business entity, but an S corp is a federal tax election that an LLC or corporation can file for.
An S corp must annually file an informational return, Form 1120S, at the federal level. An S corporation in South Carolina must file Form SC1120S to the state.
For more information about how S corps are treated in South Carolina and other important tax information, see the South Carolina Department of Revenue website. The IRS website can also provide more information on the federal guidelines for S corporations. We always recommend having a trusted tax professional by your side. They can help you with legal and financial challenges for your S corp.
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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