S-Corporations in the New Year: What Business Owners Should Know Before Making the Election

S-Corporations in the New Year: What Business Owners Should Know Before Making the Election

The beginning of a new year is one of the best times for business owners to step back and reassess their tax and entity structure. One topic that comes up frequently is whether an S-corporation election makes sense. For some businesses, it can meaningfully reduce taxes. For others, it adds cost and complexity with little benefit.

Below is a practical, plain-English overview of what an S-corporation is, why and when the election may make sense, how and when to file it, and—just as importantly—who should not make the election.

What Is an S-Corporation?

An S-corporation is not a separate type of legal entity. Instead, it is a tax election made with the IRS. Most commonly, the election is made by:

1. An LLC that wants to be taxed as an S-corporation, or

2. A corporation that qualifies and elects S-corp status.

With an S-corporation, the business generally does not pay federal income tax at the entity level, profits and losses pass through to the owners’ personal tax returns, and owners who work in the business are treated as employees, not just owners.

Why Business Owners Consider the S-Corporation Election

The primary reason is self-employment tax savings through payroll vs. distributions. In a standard single-member LLC or partnership, all net profits are typically subject to self-employment taxes.

In an S-corporation, the owners must pay themselves a reasonable salary, which is subject to payroll taxes. The remaining profits can often be taken as distributions, which are not subject to self-employment taxes.

If structured properly, this can result in meaningful tax savings once a business reaches a certain level of profitability.

When an S-Corporation Election Typically Makes Sense

An S-corporation election is often worth exploring if:

1. The business is consistently profitable,

2. Net profits are generally above $40,000–$50,000 per year,

3. The owner is actively working in the business,

4. The business has predictable cash flow, and

5. The owner is willing to run payroll and maintain proper compliance.

At higher profit levels, the tax savings often outweigh the added administrative costs.

How to Make the S-Corporation Election

The election is made by filing IRS Form 2553, where all owners must consent to the election and the form must be properly completed and timely filed. Many elections are rejected due to technical errors.

Although the form itself is short, mistakes can delay or invalidate the election—so this is an area where coordination between your attorney and CPA matters.

By When You Must Make the Election

To be effective for the current tax year, the election generally must be filed by March 15 of that year. In some circumstances, the IRS allows late S-corp elections if certain requirements are met. However, late relief is not automatic, documentation matters, and relying on late relief is avoidable with proper planning.

If you are considering an S-corp election, January and February are the ideal window to evaluate and act.

Who Should Not Make an S-Corporation Election

An S-corporation is not a one-size-fits-all solution. It is often not appropriate if:

1. The business is early-stage or not yet profitable

2. Annual profits are modest or inconsistent

3. The owner does not materially work in the business

4. The business needs flexible ownership structures

5. The business plans to admit foreign owners or certain institutional investors

6. The owner is unwilling to run payroll or maintain corporate formalities

In these cases, the added cost and complexity may outweigh any potential tax benefit.

Other Important Considerations

Reasonable Salary Rules

The IRS requires S-corp owners who work in the business to pay themselves a reasonable salary. Paying too little salary to avoid payroll taxes is a common audit trigger.

State Law and State Taxes

State tax treatment, filing requirements, and fees vary. Some states impose entity-level taxes or minimum fees on S-corporations that should be factored into the analysis.

Ongoing Compliance

S-corporations require payroll setup and regular filings, annual corporate tax returns, and proper recordkeeping and distributions. This is not a “set it and forget it” structure.

The Bottom Line

An S-corporation election can be a powerful planning tool—but only when used at the right time and for the right business. The start of a new year is the best moment to:

1. Review prior-year profitability

2. Project income for the year ahead

3. Coordinate with your CPA and attorney

4. Decide whether an S-corp election aligns with your goals

If you are unsure whether the election makes sense for your business, a short planning conversation now can prevent costly restructuring later.

If you would like help evaluating whether an S-corporation election is right for your business—or assistance making the election correctly—feel free to reach out.