DEFINITION
An S corporation isn't a separate legal entity — it's a federal tax status that can be elected by corporations or LLCs that meet specific eligibility rules. Profits and losses flow through to the owners' personal returns, and owners who work in the business must pay themselves a 'reasonable' salary subject to payroll taxes. Distributions above that salary avoid self-employment tax, which is where most of the savings come from.
WHEN IT MATTERS
When you're choosing or reconsidering an entity structure, when your business begins generating meaningful profit, or when you're being audited on owner compensation.
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COMMON QUESTIONS
When should I elect S-corp status?
Generally when net profit is high enough that the payroll-tax savings on owner distributions outweigh the cost of running payroll and a separate return — often somewhere in the $40K–$60K of distributable profit range, depending on industry.
What is 'reasonable compensation' for an S-corp owner?
An IRS-defensible salary based on what someone in your role, industry, and market would be paid as an employee. Underpaying is one of the most-audited S-corp issues.
R · RELATED TERMS
TAX
Pass-Through Entity
A business whose income passes through to its owners and is taxed on their personal returns rather than at the entity level.
TAX
Qualified Business Income (QBI) Deduction
A federal deduction of up to 20% of qualified business income for owners of pass-through entities.
TAX
Estimated Tax Payments
Quarterly payments business owners and self-employed individuals make toward their annual tax bill.