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-planning CPA or EA, with a business formation attorney, payroll provider, and bookkeeper as needed

The CPA or EA should model the election and file Form 2553. A business formation attorney handles state entity and ownership documents when legal setup is required; payroll and bookkeeping providers execute the approved operating process.

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