How to start an S corporation in Virginia

An S corporation is a federal tax status, not a separate kind of company. The business doesn't pay federal income tax itself. Its profits and losses pass through to the owners, who report their share on their personal returns. The company files an informational return, Form 1120-S, and gives each owner a Schedule K-1.

The draw for small business owners is self-employment tax. In an LLC taxed the default way, all of an active owner's profit is subject to self-employment tax. In an S corporation, owners who work in the business are paid a reasonable salary through payroll, and only that salary carries payroll taxes. Profit paid out beyond the salary as distributions doesn't.

The trade-off is cost and paperwork: running payroll, filing payroll returns and preparing a separate business tax return every year.

The IRS allows the election only if the business:

• is a domestic corporation, or an LLC eligible to be taxed as one
• has no more than 100 shareholders (family members can count as one)
• has only eligible shareholders: individuals who are U.S. citizens or residents, certain trusts and estates, and certain tax-exempt organizations. Partnerships, corporations and nonresident aliens can't own shares
• has only one class of stock (differences in voting rights alone are allowed)
• isn't an ineligible corporation, such as certain banks and insurance companies

The savings come from profit you take beyond a reasonable salary, so the election usually pays off only once the business earns comfortably more than a fair wage for the work you do. Below that point, the added payroll and tax-prep costs can outweigh the tax saved.

What counts as reasonable depends on your role, hours and industry; the IRS looks at what similar businesses pay for similar services. Our article on when to elect S corp status walks through the math, and it's worth running your numbers with a CPA.

You need a business entity before you can elect S status. In Virginia, you have two options:

Many small businesses choose the LLC route: it's simpler to run, and it can make the S election once the numbers justify it. Step-by-step instructions: form an LLC in Virginia or form a corporation in Virginia.

The IRS needs the business's Employer Identification Number on Form 2553, and you'll need it to run payroll. It's free, and an online application gets you the number right away. See what an EIN is and how to get one.

Form 2553, Election by a Small Business Corporation, asks the IRS to tax the business as an S corporation. Every shareholder (or LLC member) must sign a consent on the form. The IRS charges no fee.

Timing matters. For the election to cover the current tax year, file no more than 2 months and 15 days after the year begins, or at any time during the year before. For a new business, the tax year begins on the date it first has shareholders, acquires assets or begins doing business, whichever comes first. For an existing calendar-year business, the deadline is March 15.

An LLC that files Form 2553 is treated as having elected to be taxed as a corporation, so it doesn't also need Form 8832. If you miss the deadline, the IRS grants late-election relief in many cases where there's reasonable cause, generally within 3 years and 75 days of the date you wanted the election to start.

Virginia doesn't require a separate state election.

Corporations with a federal S election are automatically treated as S corporations for Virginia purposes and file Form 502.

Tax at the company level: No entity-level income tax unless the S corporation elects Virginia's optional pass-through entity tax (Form 502PTET).

Owners who work in the business must be paid wages through payroll before they take distributions. That means:

• withholding federal income tax, Social Security and Medicare from each paycheck
• filing federal payroll returns, such as the quarterly Form 941, and issuing W-2s each January
• registering with Virginia for state unemployment insurance and, if Virginia has a state income tax, for withholding

A payroll service makes this routine. Paying yourself too little invites IRS scrutiny, because it shifts income away from payroll taxes.

Each year, the S corporation files Form 1120-S by the 15th day of the third month after its tax year ends (March 15 for a calendar year) and sends every owner a Schedule K-1. Owners report their share of income on their personal returns.

Virginia's business tax filings are due as well. No entity-level income tax unless the S corporation elects Virginia's optional pass-through entity tax (Form 502PTET).

The S election doesn't change your state filings. The entity you formed keeps its Virginia obligations:

• LLC: Annual Registration Fee, filed every year ($50 fee). Due: By the last day of the month the LLC was formed, each year after the year of formation.
• Corporation: Annual Report and Annual Registration Fee, filed every year ($100 fee). Due: By the last day of the month of incorporation, each year after the year of incorporation.

Keep a registered agent on file, keep business and personal money separate, and put the Form 1120-S and payroll deadlines on your calendar. Worry-free compliance tracks state deadlines and files the reports for you.

State fees change from time to time. When you order through EZ Entity Setup, you see the exact state fee before you pay.