# The S corporation election

> Who can elect, the Form 2553 deadline, reasonable pay, the $7,424.33 it saves a consultant — and why Northwind can't stay one after a round.

Source: https://lopifi.com/learn/s-corporation-election
Part of: Lopifi — US GAAP books on autopilot, checked by a CPA (https://lopifi.com)

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**Should my business elect S corporation status, and who is eligible?** Who can elect, the Form 2553 deadline, reasonable pay, the $7,424.33 it saves a consultant — and why Northwind can't stay one after a round.

An [S corporation](https://lopifi.com/md/glossary/s-corporation) is a corporation, or an eligible LLC, taxed as a pass-through because it elected to be. The election is only open to a small business corporation: a domestic corporation with no more than 100 shareholders, all of them individuals (other than nonresident aliens), estates, or certain trusts and exempt organizations, and only one class of stock. Differences in voting rights alone don't make a second class.

> “a corporation shall not be treated as having more than 1 class of stock solely because there are differences in voting rights among the shares of common stock.”

— [26 U.S.C. §1361(b)(1), (c)(4)](https://www.law.cornell.edu/uscode/text/26/1361), Small business corporation: no more than 100 shareholders, eligible shareholders only, one class of stock

| Test | Northwind today | After a priced round |
| --- | --- | --- |
| Domestic corporation | Yes | Yes |
| No more than 100 shareholders | Yes — 2 | Yes |
| Only eligible shareholders | Yes — two US individuals | No — a fund organized as a partnership isn't eligible |
| No nonresident alien shareholder | Yes | Depends on the investors |
| One class of stock | Yes — common only | No — preferred stock |
| Eligible? | Yes | No — fails 2 tests |

The §1361(b)(1) tests, and Northwind against them.

> **Why a venture-backed startup can't be one.** Preferred stock — the instrument every priced round issues, with its [liquidation preference](https://lopifi.com/md/glossary/liquidation-preference) — is a second class of stock. A fund organized as a partnership can't be a shareholder at all. Northwind's planned $250,000 SAFE converts into exactly that kind of round. An S election terminates on the date the corporation stops being a small business corporation — the day a disqualified shareholder or a second class appears.

> “An election under subsection (a) shall be terminated whenever (at any time on or after the 1st day of the 1st taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation.”

— [26 U.S.C. §1362(d)(2)](https://www.law.cornell.edu/uscode/text/26/1362), An S election ends when the corporation stops qualifying, effective that date

## Electing: Form 2553

[Form 2553](https://lopifi.com/md/glossary/form-2553) is signed by every shareholder and filed no more than 2 months and 15 days after the start of the tax year the election is to take effect — or at any time in the year before. The 2 months run from the day of the month the tax year begins to the day before the same day two months later, and the 15 days follow — so for a calendar year starting January 1, March 15. An eligible LLC files Form 2553 alone; it doesn't need Form 8832 too. A missed deadline can often be cured under Rev. Proc. 2013-30.

> “Complete and file Form 2553: No more than 2 months and 15 days after the beginning of the tax year the election is to take effect, or At any time during the tax year preceding the tax year it is to take effect.”

— [Instructions for Form 2553 (Rev. December 2020), When To Make the Election](https://www.irs.gov/instructions/i2553), Form 2553 — when to elect, and relief for a late election under Rev. Proc. 2013-30

> “An entity eligible to elect to be treated as a corporation that meets certain tests discussed below will be treated as a corporation as of the effective date of the S corporation election and doesn’t need to file Form 8832, Entity Classification Election.”

— [Instructions for Form 2553 (Rev. December 2020), Purpose of Form](https://www.irs.gov/instructions/i2553), An LLC can elect S status on Form 2553 alone

- **During 2026** — Earliest: any day in 2026, the year before (Form 2553)
- **March 15, 2027** — Latest for 2027: 2 months and 15 days after January 1 (Form 2553)
- **March 15, 2028** — First S corporation return, for 2027 (Form 1120-S)

A calendar-year company electing S status for 2027.

## The salary rule, and the reason people elect

An owner who works in an S corporation must be paid [reasonable compensation](https://lopifi.com/md/glossary/reasonable-compensation) as wages, through payroll with [FICA](https://lopifi.com/md/glossary/fica), before the company makes other distributions to them. The rest of the profit passes through on the K-1 and isn't subject to self-employment tax. That gap is why profitable owner-operators elect.

> “S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee.”

— [IRS, S corporation compensation and medical insurance issues](https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues), Reasonable compensation, and the factors that set it

**Scenario — Where the election pays.** Not Northwind: a solo consultant with $150,000 of profit. As a single-member LLC, self-employment tax on all of it is $21,194.33. As an S corporation paying a $90,000 salary, FICA on both sides of that salary is $13,770, and the other $53,115 passes through without it — $7,424.33 less in Social Security and Medicare, before the cost of running payroll, a second return and any state taxes on the corporation.

**Single-member LLC**
- Pro: No payroll, no second return.
- Pro: Simplest books.
- Con: Self-employment tax on all $150,000.
- Best for: Profit too small for the savings to cover the extra costs.

**S corporation**
- Pro: $7,424.33 less in Social Security and Medicare in this scenario.
- Pro: Still one layer of income tax.
- Con: Payroll and a defensible salary every year.
- Con: Form 1120-S and K-1s.
- Con: Closes the door on preferred stock and fund investors.
- Best for: A steady, profitable owner-operator with US individual owners.

The same consultant, each way.

> **S status saves tax on profit above a reasonable salary — and is lost the day a fund or a second class of stock arrives.**

In this lesson: [reasonable compensation](https://lopifi.com/md/learn/s-corporation-election/reasonable-compensation) — what sets it, and how the salary and the distribution are booked.

## Pages in this lesson

- [Reasonable compensation](https://lopifi.com/md/learn/s-corporation-election/reasonable-compensation) — 4 min. What is reasonable compensation for an S corp owner?

## Where this lesson's rules come from

- [26 U.S.C. §1361(b)(1), (c)(4)](https://www.law.cornell.edu/uscode/text/26/1361) — Small business corporation: no more than 100 shareholders, eligible shareholders only, one class of stock (statute)
- [26 U.S.C. §1362(d)(2)](https://www.law.cornell.edu/uscode/text/26/1362) — An S election ends when the corporation stops qualifying, effective that date (statute)
- [Instructions for Form 2553 (Rev. December 2020), When To Make the Election](https://www.irs.gov/instructions/i2553) — Form 2553 — when to elect, and relief for a late election under Rev. Proc. 2013-30 (irs)
- [Instructions for Form 2553 (Rev. December 2020), Purpose of Form](https://www.irs.gov/instructions/i2553) — An LLC can elect S status on Form 2553 alone (irs)
- [IRS, S corporation compensation and medical insurance issues](https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues) — Reasonable compensation, and the factors that set it (irs)
- [IRS, S corporations](https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations) — S corporations — eligibility and Form 2553 (irs)
- [Form 2553 (Rev. December 2017)](https://www.irs.gov/pub/irs-pdf/f2553.pdf) (PDF) — Form 2553, Election by a Small Business Corporation (PDF) (form)
- [Form 1120-S (2025)](https://www.irs.gov/pub/irs-pdf/f1120s.pdf) (PDF) — Form 1120-S, U.S. Income Tax Return for an S Corporation (PDF) (form)
- [Wikipedia, “S corporation”](https://en.wikipedia.org/wiki/S_corporation) — S corporation (reference)

## Read further

- https://lopifi.com/md/startups/payroll-journal-entries

- **Track:** [Entity types](https://lopifi.com/md/learn/entities)
- **Lesson:** Lesson 3 of 9 — 10 min
- **Terms taught:** [S corporation](https://lopifi.com/md/glossary/s-corporation), [Form 2553](https://lopifi.com/md/glossary/form-2553), [Reasonable compensation](https://lopifi.com/md/glossary/reasonable-compensation), [Schedule K-1](https://lopifi.com/md/glossary/schedule-k-1), [Liquidation preference](https://lopifi.com/md/glossary/liquidation-preference)
- **Previous:** [State taxes on the entity, Entities · Lesson 2](https://lopifi.com/md/learn/how-business-entities-are-taxed/state-entity-taxes)
- **Next:** [Reasonable compensation](https://lopifi.com/md/learn/s-corporation-election/reasonable-compensation)
- **The course:** https://lopifi.com/md/learn