Choosing a business structure affects how a company pays taxes, handles compliance, and distributes profit. An S corporation is not its own legal entity. It is a tax election you make with the IRS. Most business owners start by forming an LLC or a C corporation at the state level, then file for S corp status on top of that. Once the election is in place, it changes how the federal government taxes your company’s income.
Deciding whether an S corp makes sense for your business means looking at your revenue, your administrative costs, how you pay yourself and any employees, and your retirement contributions. The right answer depends on a few specific tax rules, which we break down in this article.
Tax Benefits of the S Corporation Election
Most business owners choose the S corp election for one reason: tax savings. Here is where those savings come from.
Elimination of Double Taxation
A traditional C corporation gets taxed twice. The company pays tax on its profit, and then shareholders pay tax again when that profit is distributed to them as dividends.
An S corp election removes that second layer of tax. The IRS treats it as a pass-through entity, which means:
- The business itself pays no federal corporate income tax.
- Profits and losses flow directly to the owners’ personal tax returns.
- Shareholders report their share of the company’s income on a Schedule K-1 and pay tax at their personal rate.
This keeps more money in the business and in your pocket, instead of losing a chunk of it to a second round of tax.
Lower Self-Employment Tax
If you run a sole proprietorship or a standard LLC, you pay self-employment tax on all your business profit. That tax is 15.3%, covering Social Security and Medicare.
An S corp lets you split your income into two buckets: salary and distributions. You pay yourself a reasonable salary for the work you do. That salary goes through payroll and is subject to the usual payroll taxes. Any profit left over can be paid out as a distribution. Distributions are not subject to the 15.3% self-employment tax.
Here is what that looks like in practice. Say your business earns $100,000 in profit. As a sole proprietor, you would owe self-employment tax on the full $100,000. As an S corp, you might pay yourself a $60,000 salary based on fair market rates for your role. The remaining $40,000 is paid out as a distribution. That $40,000 is not subject to the 15.3% tax, saving you about $6,120.
State Pass-Through Entity Taxes
Federal law limits how much state and local tax you can deduct on your personal return. That cap rose from $10,000 to $40,000 starting in 2025, but it phases out once your modified adjusted gross income passes $500,000 and never drops below $10,000. Many higher earners are still capped close to the old limit, which is exactly where the pass-through entity tax election helps.
Here is how it works. Instead of the state tax liability passing through to your personal return, the S corp itself pays the state tax directly, using business funds. The company then deducts that payment as a normal business expense on its federal return. That lowers the profit that shows up on your K-1, and shareholders get a credit to offset what they owe personally. The result is that a tax that used to be capped on your personal return becomes a fully deductible business expense instead.
In Illinois, S corps can elect to pay a flat 4.95% tax at the entity level. Making this election means the company skips the standard 7% Illinois corporate tax that C corps pay. Keep in mind that Illinois still charges a separate 1.5% Personal Property Replacement Tax on S corp net income, regardless of whether you make the pass-through election. That tax does not go away.
Administrative and Financial Drawbacks of S Corporations
The tax savings come with some strings attached. If you do not stay on top of the requirements, you risk losing your S corp status and facing penalties.
You Need a Real Payroll System
Once you elect S corp status, you cannot just pull money out of the business whenever you want. You need a formal payroll system that withholds taxes and files quarterly payroll reports (Form 941) on time. Setting this up and running it adds ongoing cost.
The IRS also pays close attention to the salary-versus-distribution split. If your salary looks too low compared to the distributions you take, the IRS can decide you are trying to dodge self-employment tax. If they catch this in an audit, they can reclassify your distributions as wages and hit you with back taxes, interest, and penalties. To protect yourself, keep documentation showing your salary matches what similar roles pay in the market.
Profits Must Match Ownership
S corps cannot get creative with how they split profits and losses. Whatever percentage of the company you own, that is the percentage of profit, loss, and distributions you must receive. If you own 60% of the company, you get exactly 60% of the profit and absorb exactly 60% of the losses.
LLCs and partnerships can make special allocations, splitting income based on effort or investment rather than ownership. S corps cannot. Deviating from strict ownership percentages breaks the single class of stock rule and can end your S corp status entirely.
Ownership Rules Limit Your Options
The IRS puts firm limits on who can own an S corp and how many owners it can have:
- No more than 100 shareholders.
- Shareholders must be individuals who are U.S. citizens or resident aliens, or certain trusts and estates.
- Other corporations, partnerships, and non-resident aliens cannot own shares.
- The company can only have one class of stock, though different voting rights are allowed.
Illinois adds a few more requirements. S corps there owe that 1.5% Personal Property Replacement Tax mentioned above, on top of any other state obligations. And if your S corp has shareholders who do not live in Illinois, the company is responsible for withholding tax on their behalf at the 4.95% rate.
Considering an S Corp Election?
Switching to an S corp takes careful planning, and timing matters. At The Hechtman Group, we help you figure out whether the election makes sense for your business and guide you through the process from start to finish.
We work with real estate companies and other businesses across a range of industries, and we know that tax rules for real estate look different from other fields. Our team can walk you through financial reporting, acquisition and disposition planning, energy credits, tax planning, and more. Contact us today to talk through whether an S corp is the right move for you.
FAQs
What are the requirements for becoming an S corporation?
The IRS sets a few basic rules. Your company can have no more than 100 shareholders, and each one must be a U.S. citizen or meet the green card or substantial presence test. The business also needs to be a domestic company with only one class of stock.
At what income level does an S corp election start to make sense?
Most businesses see real value once profit reaches $100,000 to $150,000 a year, but also depends on how much you plan to contribute to retirement. The self-employment tax savings usually outweigh the added costs of running payroll and filing a separate corporate tax return (Form 1120-S).
How do S corp owners actually get paid?
Through a mix of salary and distributions. You receive a regular paycheck through payroll that reflects fair market pay for your role. Any remaining profit is paid out separately as a distribution, which is not subject to self-employment tax.