When to Change Your Tax Filing Status to an S-Corporation

Written By Noah Saul

If you’re running a side business—maybe you’re freelancing, selling products online, or offering consulting services—you’ve probably heard about S corporations (S corps) and wondered if you should make your business one. Here’s a plain-English guide to help you decide if and when to make the switch, what the pros and cons are, a simple example, and how to actually file for S corporation status with the IRS.

What Is an S Corporation?

An S corporation is a special type of corporation that passes its income, losses, deductions, and credits through to its shareholders for federal tax purposes. This means the business itself generally doesn’t pay federal income tax. Instead, the profits (or losses) are reported on the owners’ personal tax returns. This can help you avoid the “double taxation” that regular C corporations face, where both the company and the owners pay tax on the same money.

When Should You Consider Becoming an S Corporation?

You might want to consider S corporation status if:

  • Your business is making a steady profit (after expenses).

  • You’re paying yourself a salary and could benefit from saving on self-employment taxes.

  • You want to separate your personal and business finances and protect your personal assets.

  • You’re ready to deal with a bit more paperwork and follow some IRS rules.

If your business is still losing money, or you’re not making much more than you’d pay yourself as a reasonable salary, it might not be worth the extra hassle yet.

Pros and Cons of S Corporation Status

Pros

  1. Tax Savings on Self-Employment Taxes
    As a sole proprietor or single-member LLC, you pay self-employment tax (Social Security and Medicare) on all your business profits. With an S corp, you pay yourself a “reasonable salary” (which is subject to payroll taxes), but any remaining profits can be distributed as dividends, which aren’t subject to self-employment tax.

  2. Pass-Through Taxation
    The business itself doesn’t pay federal income tax. Profits and losses pass through to your personal tax return.

  3. Potential for More Credibility
    Operating as a corporation can make your business look more professional to customers, vendors, and lenders.

  4. Limited Liability Protection
    Like an LLC or C corporation, an S corp generally protects your personal assets from business debts and lawsuits.

Cons

  1. More Paperwork and Costs
    You’ll need to run payroll, file extra tax forms, and keep good records. There may be state fees and annual reports.

  2. IRS Scrutiny of “Reasonable Salary”
    The IRS requires you to pay yourself a reasonable salary for the work you do. If you try to pay yourself too little to avoid payroll taxes, you could get audited and penalized.

  3. Ownership Restrictions
    S corps can’t have more than 100 shareholders, and all must be U.S. citizens or residents. Only certain types of trusts and entities can be shareholders.

  4. One Class of Stock
    S corps can only have one class of stock, which limits flexibility in how you structure ownership.

A Simple Example

Let’s say you run a side consulting business and make $100,000 in profit after expenses.

  • As a sole proprietor or single-member LLC:
    You pay self-employment tax (about 15.3%) on the full $100,000, plus income tax.

  • As an S corporation:
    You pay yourself a reasonable salary—let’s say $60,000. You pay payroll taxes on that $60,000, but the remaining $40,000 can be distributed as a dividend, which isn’t subject to self-employment tax. This could save you thousands in taxes.

But: You’ll need to run payroll, file quarterly payroll tax returns, and possibly pay for accounting help.

Step-by-step: how to become an S corporation

1) Start with the right legal entity (state step)

You need a business entity created under state law, usually:

  • LLC (most commonly recommended for small businesses and anyone reading this), or

  • Corporation (C corporation by default, then you elect S status)

Typical LLC formation steps (state-specific):

  • File Articles of Organization with your state

  • Pay the state fee

  • Create an Operating Agreement (highly recommended even if not required)

  • Get any required state/local licenses

Important: “S corp” doesn’t replace your LLC. It’s a tax status you elect for an existing business entity (usually an LLC or a corporation) so profits generally “pass through” to the owners’ personal tax returns.

2) Get an EIN (federal step)

Apply for an Employer Identification Number (EIN) with the IRS if you don’t already have one. You’ll use it for payroll and tax filings.

3) Confirm you’re eligible for S corp status

In plain terms, you generally must have:

  • 100 or fewer owners (shareholders)

  • Owners are U.S. individuals

  • Only one class of ownership economically (you can have different voting rights, but not different rights to profits/distributions)

  • Not a disallowed business type (some banks/insurance companies, etc.)

If your ownership is complicated (entities as owners, foreign owners, multiple profit-sharing arrangements), confirm eligibility before filing.

4) Pick your “effective date” (when it starts)

To start S status for a given tax year, you usually must file within 2 months and 15 days after the start of that tax year (often the calendar year). However, don’t panic if this time frame as passed. There is late relief provided by the IRS, which we will discuss further below.

5) File IRS Form 2553 (this is the actual S corp election)

You file Form 2553: Election by a Small Business Corporation.

Who must sign

  • An authorized company officer/authorized person signs for the entity

  • All owners (shareholders) must consent (they usually sign on the form)

Signature format (practical point)

  • Form 2553 is commonly filed by mail or fax, and the IRS has historically required a handwritten (“wet”) signature for mailed/faxed submissions. (Rules and IRS acceptance practices can evolve—many people still follow the conservative approach: wet signatures.)

6) Mail it with tracking (strongly recommended)

Mailing certified mail (or another trackable method) is useful because it gives you proof of:

  • When you sent it, and

  • That you have a mailing receipt if the IRS later says they didn’t get it

Keep the receipt and a full copy of the signed form in your permanent records.

If you missed the deadline (late election relief)

If you filed late, you may still be able to fix it under Revenue Procedure 2013-30 (common late-election relief), if:

  • You intended to be an S corp as of the effective date

  • The late filing was due to reasonable cause

  • You file within 3 years and 75 days of the intended effective date

  • Owners reported taxes consistently with S corp treatment during the period

Practical filing tip often used:

  • Write “FILED PURSUANT TO REV. PROC. 2013-30” at the top of Form 2553

  • Include a brief “reasonable cause” statement (what happened, when you found it, how you corrected it)

If you don’t qualify for this relief, the next path is typically a more formal request (more time/cost).

After you become an S corp: set up payroll (don’t skip this)

If an owner works in the business, the IRS expects the owner-employee to be paid reasonable compensation through payroll (W-2 wages), not only owner profit distributions.

What you do in practice

  • Register payroll tax accounts (federal + state)

  • Use a payroll provider (e.g., Gusto/ADP/Paychex) or a payroll accountant

  • Run payroll on a set schedule

  • File/pay payroll taxes (often handled by the provider)

  • Issue W-2s at year-end

Simple checklist (one page)

  1. Form LLC or corporation with your state

  2. Get EIN

  3. Confirm S corp eligibility

  4. Choose effective date

  5. Complete Form 2553 + all owner consents

  6. Submit with tracking; keep proof

  7. If late: consider Rev. Proc. 2013-30 relief

  8. Set up payroll; pay owner-employee a reasonable wage

Bottom Line

Becoming an S corporation can save you money on taxes if your business is profitable and you’re ready for the extra paperwork. It’s not for everyone, but for many side business owners, it’s a smart move once your profits grow. Talk to a tax professional to see if it’s right for you, and if you decide to go for it, follow the steps above to make it official with the IRS.

Disclaimer: This post is for general information only and isn’t tax or legal advice. Always consult a qualified tax professional for advice specific to your situation.

Noah Saul