Setting Up an S Corporation

How to form your S-Corp and properly pay yourself as an owner

Many small business owners reach a point where it makes sense to become more strategic about taxes and how they pay themselves. One of the most effective structures to accomplish this is forming an S Corporation (S-Corp).

An S Corp can provide valuable tax advantages, particularly by allowing business owners to take part of their earnings as distributions rather than wages—potentially saving thousands in self-employment taxes. However, setting up and maintaining an S-Corp correctly is key to keeping those benefits and staying compliant with the IRS.

Below we break down the steps for setting up an S-Corporation and explan how owner payroll should be handled once the business is established.

What Is an S Corporation?

An S Corporation isn’t a type of business entity like an LLC or corporation—it’s a tax election made with the IRS. When you elect S-Corp status, your company’s profits “pass through” to the owners’ personal tax returns, and you avoid double taxation that occurs with traditional C-Corporations.

Here’s how it works:

• Your business must first be registered as an LLC or Corporation at the state level.
• Then, you file Form 2553, Election by a Small Business Corporation, with the IRS to request S Corp status.
• Once approved, your business will be taxed under S Corp rules starting that year (if the election is timely filed).

This election changes how income is reported and how the owners are paid.

Steps to Set Up an S Corporation

Below we outline the key steps required to set up your S Corp and ensure it’s properly structured from the start.

• Form Your Business Entity

File Articles of Organization (for an LLC) or Articles of Incorporation (for a corporation) with your state. Choose a business name, appoint a registered agent, and obtain an Employer Identification Number (EIN) from the IRS.

• File Form 2553 with the IRS

To elect S-Corporation status, submit IRS Form 2553 within 75 days of forming your business (or by March 15 if you want the election to apply for the full tax year). Late elections may still be accepted if reasonable cause is provided.

• Set Up a Separate Business Bank Account

Keep business and personal finances completely separate. Open a dedicated business checking account to handle all income and expenses.

• Register for Payroll and State Accounts

You’ll need to register with your state’s Department of Revenue and unemployment office for payroll tax purposes. Even if you are the only owner-employee, the S-Corp must issue payroll like any other employer.

• Set Up Payroll for the Owner(s)

This step is critical. The IRS requires S-Corp owners who provide services to the company to receive a “reasonable salary” through payroll, subject to employment taxes.

Failure to do so can result in IRS penalties and reclassification of distributions as wages.

What Is Considered a “Reasonable Salary”?

The IRS doesn’t provide a specific dollar amount—it depends on the type of work performed, the industry, and the company’s profitability.

To determine a reasonable salary:

• Research what others in similar roles earn.
• Consider the time and effort you devote to the business.
• Evaluate the business’s ability to pay.

A good rule of thumb is to ensure the salary aligns with fair market compensation for your position before taking additional distributions.

What You Need for Owner Payroll

Once your S-corp election is approved, payroll for owners should include the following:

• Payroll system: Use a reputable service (Gusto, QuickBooks Payroll, ADP, etc.) to calculate, withhold, and remit payroll taxes.
• Tax withholdings: Federal income tax, Social Security, and Medicare taxes must be withheld from each paycheck.
• Employer taxes: The S-Corp must also pay the employer’s portion of Social Security and Medicare.
• Payroll filings: File quarterly and annual payroll tax forms (Form 941, Form 940, and W-2s at year-end).
• Consistent payments: Owner payroll should be paid regularly, just like any employee.

Distributions, on the other hand, can be paid periodically outside of payroll and are not subject to payroll taxes—offering the tax savings benefit of S-Corp status.

Example

Suppose a Real Estate Broker or Agent S-Corp earns $100,000 in profit for the year. The owner actively works in the business.

• The owner pays themselves a reasonable salary of 40,000 via payroll (subject to Social Security and Medicare).
• The remaining $60,000 can be taken as a distribution, which is not subject to self-employment taxes.

By doing this correctly, the owner may reduce overall payroll tax liability while remaining fully compliant with IRS guidelines.

Key Takeaways

• An S Corporation is a tax election that can provide significant tax savings when structured properly.
• To qualify, your business must be an eligible LLC or corporation with fewer than 100 shareholders.
• Owners who work in the business must take a reasonable salary through payroll. Typically 20-30% of gross revenue should be paid as wages as a good rule of thumb.
• Proper payroll setup, recordkeeping, and compliance with IRS rules are essential to maintaining S Corp benefits.

The Bottom Line

Setting up and maintaining an S-Corporation can be a powerful tax strategy for small business owners—but it must be done right.

At CFO Associates, we help business owners determine if an S-Corp election makes sense for them, guide them through setup, and ensure payroll and tax filings are handled properly.

If you’re considering becoming an S-Corp or need help setting up owner payroll, schedule a call with our team to discuss your specific situation and other tax planning strategies. We’ll help you structure your business for compliance and savings.