IRC §1362, IRC §1401

S-Corporation Election

An S-Corporation election splits your business income into two buckets: a W-2 salary (subject to payroll taxes) and distributions (not subject to self-employment tax). The savings is the SE tax you avoid on the distribution portion.

Note that the figure shown is gross — ongoing payroll administration, state franchise taxes (CA, NY), and your accountant’s additional time are real costs that reduce the net benefit. This also spans two tax filings: a corporate return (Form 1120-S) plus your personal return via Schedule K-1.

Who this may apply to

Business income exceeds $80,000+/year
Currently operating as sole proprietor, LLC, or partnership
Able to pay yourself a "reasonable salary"
U.S. citizen or resident alien

Strategy connections

Enables

Reasonable Salary Optimization: Creates the owner-employee compensation requirement.
Compensation Structure Optimization: Allows owner pay to be coordinated across salary and distributions.
Accountable Plan: Allows qualifying employee business expenses to be reimbursed under a written plan.

Works well with

Solo 401(k) / SEP-IRA Optimization: W-2 compensation affects employer retirement contributions.
Qualified Business Income (QBI) Deduction: Owner salary and pass-through income both affect the QBI calculation.
PTET (Pass-Through Entity Tax) Workaround: An eligible S corporation may be able to make a state PTET election.

Watch out

Hiring Children: Corporate employers generally do not receive the family-employment payroll tax exceptions available to some sole proprietors and partnerships.

What could block this

No qualifying business activity or income
Ownership, shareholder, or entity rules that prevent an S election
Administrative cost that outweighs the expected benefit

Important considerations

Setting your salary too low is the #1 audit trigger for S-Corps — the IRS requires ‘reasonable compensation’ comparable to what you’d pay an outside hire for the same work
S-Corp elections cannot be easily undone — once elected, you typically must wait 5 years to revoke
If you have children employed in your business as a sole proprietor, converting to an S-Corp eliminates the FICA tax exemption on their wages — weigh this trade-off
California imposes an additional 1.5% entity-level franchise tax on S-Corp net income (minimum $800/year). This reduces but does not eliminate the FICA savings — our estimates already account for this offset.
New York imposes an Article 9-A franchise tax on S-Corps based on NY receipts — typically $75–$500/year for most small businesses ($100K–$500K income). Already factored into our NY estimates.
Massachusetts S-Corps may be subject to an 8% corporate excise on certain income streams. Verify with a MA-licensed CPA before electing.
Payroll compliance is mandatory — failure to file quarterly returns or deposit payroll taxes results in significant penalties

Professional support

Tax Strategist or CPA

Can file Form 2553, set up payroll for reasonable salary, and ensure ongoing compliance with S-Corp requirements.

Timing

Form 2553 is generally due no later than 2 months and 15 days after the requested effective date. March 15 is the usual deadline for an existing calendar-year entity, while a newly formed entity may have a different date. Late-election relief may be available when its requirements are met.

Official sources

Reviewed 2026-07-24