File an S Corp in Washington State

Are you considering establishing an S corporation in Washington state but feel uncertain about the process? Our guide is here to assist you. It offers detailed insights into the advantages and procedural aspects of forming S corporations, alongside the support we provide to streamline your startup journey.

In Washington state, electing S corp status for a limited liability company (LLC) might result in potential self-employment tax savings for its owners. Similarly, for C corporations (C corps), adopting an S corp structure can prevent the double taxation of business profits, enhancing financial efficiency for companies operating within the state.

Requirements and Limitations of S Corporations

You need to know a few S corp filing requirements and limitations before you begin this process. Specifically, to qualify for S corporation status, 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 only one class of stock (for C 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 allowable members or shareholders, which includes individuals and certain trusts and estates. The shareholders may not be partnerships, corporations, or non-resident aliens. A nonresident alien is an alien who hasn’t passed the green card test or the substantial presence test.

As you can see, not all business entities are eligible for S corp classification. However, if your business entity meets these requirements, you can apply for an S corp election. 

Washington-Specific Considerations

In an S corp, the business itself doesn’t usually pay federal income tax. But what about state income taxes?

While many states impose an income tax on earnings, Washington State does not have a personal or corporate income tax. But S corporations in Washington are required to pay the Business and Occupation (B&O) tax. This is not a tax on the profits (the money you have left after all expenses are paid) but on the gross receipts, the total amount of money the business brings in. Every S corporation in Washington must pay taxes for the B&O, even if it isn’t making any profits. Some local governments also impose an additional B&O tax of their own.

Moreover, businesses, including S corporations, are required to file an Excise Tax Return with the state of Washington, detailing their gross receipts and computing the B&O tax owed. This step is critical to maintaining compliance with state regulations and avoiding any potential legal and financial issues.

How to Start an S-Corp in Washington

To create a Washington S corporation, you’ll 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 Internal Revenue Service (IRS).

S-Corp Election Steps for LLCs

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

• Step 1 – Choose a Name
• Step 2 – Appoint a registered agent
• Step 3 – File a Washington Certificate of Formation
• 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 Washington Corporation formation guide.

• Step 1 – Name Your Washington Corporation
• Step 2 – Appoint Directors
• Step 3 – Choose a Washington Registered Agent
• Step 4 – File the Washington Articles of Incorporation
• 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 to apply for S corp status

Submit the form to apply for S corporation status. Once your LLC or C corporation formation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to make an S corp election. 

The IRS requires that you complete and file your Form 2553: 

• Within 75 days of the formation of 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.

One important note 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.

Pros and Cons of Filing as an S Corp

While S corp election does come with benefits for some businesses, this election might not be right for all business types. So, be sure to carefully consider the pros and cons before deciding how you want to move forward. Ask a tax professional about whether the S corp election would be best for your business.

Advantages of S Corp Status for LLCs

The advantages of filing as an S corp for an LLC aren’t quite the same as they are for a C corporation. Let’s first look at the advantages for LLCs.

A traditional LLC already has pass-through taxation by default, so the benefits of S corp election for an LLC involve self-employment taxes. This takes some explanation, but for certain LLCs, it could save a significant amount in federal taxes.

Self-Employment Taxes

The members of an LLC without S corp election are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be an employee of 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 more than the taxes they’d pay when working for someone else because their employer would pay half of them.

Dividing Profits and Salary

When the members elect S corp status, they can be compensated in two ways, by receiving their share of the profits and by being paid as an employee. Once that happens, 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, they’ll still pay income taxes 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

Note 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 one dollar and avoid contributing anything to Social Security and Medicare. 

So, what’s considered “reasonable compensation”? 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 100% defined, the IRS seems to consider “reasonable” to be something in line with what others in your field are earning.

If the IRS decides that your salary isn’t reasonable, it can reclassify your non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). Several court cases have supported the IRS’s right to do this.

Advantages of S Corp Status for C Corporations

If you have a C corporation (which is the default form of corporation), filing as an S corp does have its advantages:

No Double Taxation

A 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, 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 business owner level. The business itself isn’t taxed on them. This is called “pass-through taxation,” and it’s how sole proprietorships and general partnerships are taxed. LLCs are also taxed this way unless they choose to be taxed as a corporation. More on the pass-through taxation definition.

We need to add here that, since the 2017 Tax Cuts and Jobs Act, the corporate tax rate has been lowered to a flat 21%. So, the disadvantages of double taxation aren’t as major now as they were. 

Writing Off Losses

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 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 the first couple of years. Still, make sure you’re aware of ​​the IRS’s shareholder loss limitations.

QBI Deduction

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

QBI is essentially 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 you exceed it, may reduce your QBI (see the IRS website for details).  

Disadvantages of S Corp Status for LLCs

Having an LLC with S corp tax designation also comes with some disadvantages compared to a traditional LLC:

Stricter Requirements 

As we mentioned, S corps have more qualifications 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.

More Scrutiny

Because of the above restrictions and the requirements about paying yourself a “reasonable salary,” the IRS 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 light of this, S corp owners may want to observe some of the same formalities that C corporations do (such as extensive record keeping), even if they’re not legally required to.

More Accounting and Bookkeeping

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 do so. Your taxes will also be more complex.

With these added complications, you’re likely to have higher administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.

Disadvantages of S Corp Election for C Corporations

S corp status also has its drawbacks for C corporations:

No More Than 100 Shareholders

As we said, an S corp can’t have more than 100 shareholders, while a C corporation has no such restriction. That limitation could become an issue if the corporation expands and goes public.

Limited Shareholder Types

All S corp shareholders must be U.S. citizens, or certain trusts or estates. That may limit your ability to expand outside of the U.S. You also can’t have partnerships or corporations as shareholders. C corporations don’t have limitations like this.

Only One Class of Stock

One way corporations attract investors is to offer preferred stock, but that’s not allowed for S corps.

More IRS Scrutiny

Because of the extra restrictions S corps have, the IRS watches them more closely to see if they’re in compliance, meaning, your corporation is more likely to get audited.

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

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 Washington LLC with S corp tax election

Forming a business can be complicated, but we’re here to make it as easy for you as possible.

When you’re ready to take the leap, we can help you form a Washington LLC with an S corporation designation and provide you with valuable support for all of your business needs moving forward.