In the past few months, several people have reached out to me with some variation of the same question: what is an “S-Corp?” Most of them were exposed to the term by TikTok, Facebook Reels, and other short-form video platforms. While those platforms are great for entertainment and simple educational content, the videos I reviewed did not really explain the concept well.
As with other articles on my blog, this is intended for general education purposes only. Your particular business may or may not be able to benefit from S-Corp status. The requirements for an S-Corp election are also fairly complicated and beyond the scope of this article. Please reach out to our office if you would like a consultation regarding your business’s formation, tax strategy, or other applicable subjects.
S-Corporation vs C-Corporation
At its simplest level, a “small business corporation,” “S-Corp” or “S-Corporation” is a tax election allowed by the IRS for certain qualifying business entities. The Internal Revenue Code provides significant flexibility for businesses in their tax planning and SCorp status is just one of several options available.i
A corporation, or “C-Corp,” is a business entity itself similar to an Limited Liability Company (LLC). Corporations are usually registered through a state’s Secretary of State, require periodic filings to remain registered, and must meet various requirements under state law.
As you can see, these are two entirely different concepts. A C-Corp can elect to be taxed as an S-Corp because one is a business entity while the other is an election made to the Internal Revenue Service. The requirements for an S-Corp election are complicated and exceed the scope of this article. One requirement that is relevant, however, is that S-Corp owners must be paid a “reasonable salary.” This is important because of the primary benefit of an S-Corp election as explained in the videos referenced above.
Primary Benefit of S-Corp Status
The reasons for electing to be treated as an S-Corp are broad and largely depend on a business’s industry, shareholders, and goals. With that said, the primary reason I see in the short-form videos referenced above from TikTok, Facebook Reels, etc. is that S-Corp status allows small companies to minimize their Federal Insurance Contribution Act (FICA) liabilities, commonly known as Medicare and Social Security taxes.
Most people who have earned a paycheck know that their gross pay is reduced when FICA contributions — Medicare and Social Security — are deducted by an employer.
As of this writing, the Social Security tax rate is 12.4% and Medicare sits at 2.9%. A wage earner working for a company only has half of those rates — 6.2% and 1.45%, respectfully — deducted from their paycheck; your employer pays half of the tax. When you start your own business, you are still liable for these contributions.
The relevant question to understanding why S-Corp election is important is: how much of my earnings are subject to FICA taxation? If you are operating through an LLC, you are taxed as if you are a sole proprietorship.
This means you owe FICA taxes on all of your earnings up to the statutory limits. Electing to be treated as an S-Corp, in contrast, allows a business owner to limit this tax liability to the “reasonable salary” paid to her.
Example – No S-Corp: Business Owner earns $100,000 after eligible deductions. The entire $100,000 will be subject to 15.3% (Social Security & Medicare combined) in FICA contributions equaling $15,300. This is on top of any income tax owed to the IRS.
Example – S-Corp Status: Business Owner pays herself a “reasonable salary” of $50,000 and earns another $50,000 after eligible deductions. Only the $50,000 salary will be subject to the 15.3% FICA deduction requirement. The other $50,000 will only be taxed as income.
As I said at the outset, whether an S-Corp election is possible or a good fit for your business goes far beyond the scope of this article. If you would like to set up a consultation regarding your business’s legal status and tax strategy, please call our office at (903)221-9180 or email our Client Services Director, Evelyn Burrows, at evelyn@matthewlewislaw.com to set up a consultation.
i 26 U.S.C. §§ 1361–1379 (commonly known as “Subchapter S”)
