Form a DC S Corp

Considering launching an S corporation in the District of Columbia? This move could significantly impact your tax strategy, offering valuable savings. An S corp isn’t a type of business itself but a tax designation that allows businesses to enjoy certain financial benefits.

This option is particularly appealing for owners of a limited liability company (LLC) in D.C. Under normal circumstances, all income from an LLC would be subject to self-employment taxes. However, electing to be taxed as an S corp changes the game: owners can take a portion of the business’s income as a salary, on which self-employment taxes are paid. The remaining income, distributed as dividends, is not subject to these taxes, potentially leading to considerable tax savings.

This guide aims to demystify the process of setting up an S corp in the District of Columbia, focusing on how to harness these tax advantages while navigating the requirements and helping ensure your business meets all the necessary criteria.

District of Columbia S Corp Filing Requirements

There are a few S corp filing requirements and limitations you should be aware of before you begin this process. Specifically, to qualify for S corporation status, an entity must:

• Be a domestic corporation or LLC
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations
• Have only one class of stock
• Have no more than 100 shareholders or members (“shareholders” is the term for owners of a corporation, while “members” is the term for owners of an LLC)
• Have only allowable shareholders or members, which includes individuals, certain trusts, and estates. The shareholders may not be partnerships, corporations, or non-resident aliens. A nonresident alien is an alien who has not passed the green card test or the substantial presence test.

Not all business entities are eligible for S corp classification. However, if your business entity meets these requirements, you can apply for an S corp election. 

Considerations for DC S Corp Taxes

In an S corp, the business itself doesn’t usually pay federal income taxes. But what about DC income taxes?

The District of Columbia doesn’t recognize S corp elections. You can still be an S corp on the federal level, but for DC tax purposes, the District will treat you like a C corporation. This means you’ll be responsible for all the DC taxes your company would pay if it were a C corporation.

Corporations must also pay a minimum tax of $250 if DC gross receipts are $1 million or less. There’s a $1000 minimum tax if DC gross receipts are more than $1 million.

How to Start an S Corp in the District of Columbia

To create a District of Columbia S corporation, you’ll need to create either a limited liability company (LLC) or a C corporation if you haven’t already done so. Then, you’ll file an election form with the IRS.

Forming a DC LLC

1. Name your District of Columbia LLC
2. Appoint a registered agent in the District of Columbia
3. File District of Columbia Articles of Organization
4. Create an operating agreement
5. Apply for an EIN
6. Apply for S Corp status with IRS Form 2553

For more details on these steps, visit our “Start a District of Columbia LLC” page.

Forming a DC Corporation

1. Name your District of Columbia (DC) corporation
2. Appoint Directors
3. Choose a District of Columbia (DC) Statutory Agent
4. File the District of Columbia (DC) Articles of Incorporation
5. Create Corporate Bylaws
6. Draft a Shareholder Agreement
7. Issue shares of stock
8. Apply for Necessary Business Permits or Licenses
9. File for an EIN and review tax requirements
10. Submit Your Corporation’s First Annual Report
11. Apply for S Corp status with IRS Form 2553

If you’d rather form a District of Columbia corporation, follow the instructions on our DC incorporation page.

File form 2553 to apply for S corp status

Once your LLC or C corporation formation is approved by the state, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corp status. 

The IRS requires that you complete and file your Form 2553: 

• Within 75 days of the formation of your LLC or C corporation, or no more than 75 days after the beginning of the tax year in which the election is to take effect

OR

• At any time during the tax year preceding the tax year the election is to take effect.

One caveat for LLCs wishing to file as an S corp: If your LLC is past the 75-day election deadline, you’ll also need to file Form 8832, Entity Classification Election, to elect to be taxed as a corporation. Then you would file both Form 8832 and Form 2553 together via USPS-certified mail. 

Note that all of the shareholders/members must sign the consent statement portion of the form. For more information on when and how to file Form 2553, visit the IRS website.

Keeping Your S Corp Compliant

Regardless of S corp status, an LLC or a corporation must file a biennial report and pay an accompanying fee of $300 every two years. The purpose of the report is to update the DC government as to the basic information about your company. The report is due on April 1 of the year following the year in which the LLC or corporation was formed and every two years thereafter.

If you began your S corporation as a C corp, you’ll need to follow all the requirements for a DC corporation. This includes holding an annual shareholder meeting at a time established in the bylaws or Articles of Incorporation (§ 29–405.01).

Pros and Cons of Filing as S Corp for LLCs and Corporation in DC

While S corp classification does come with a number of benefits for some businesses, making this election might not be right for all companies. So, be sure to carefully weigh the various pros and cons before deciding how you want to move forward. Consult a tax professional about whether the S corp election would be best for your business.

Advantages of S Corp Status for LLCs

The advantages of filing as an S corp for an LLC aren’t exactly the same as they are for C corporations. A traditional LLC already has pass-through taxation, so the benefits of S corporation election for an LLC have to do with federal self-employment tax. We’ll explain.

Self-Employment Taxes Explained

The members of a standard LLC are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (Social Security and Medicare, which add up to about 15.3%) on all profits they receive from the LLC. This is more than the taxes they’d pay when working for someone else because their employer would pay half of them.

Dividing Salary and Profits

But when the members elect S corp status, they can be compensated in two ways, by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay Social Security and Medicare taxes on their salary and not the profits they receive. Depending on factors such as how profitable your company is, the savings could add up to a lot. (Of course, the members will still pay income and all other applicable taxes on their share of the profits and any other taxable income.) Money paid out as salary is a tax-deductible expense for the business. 

Reasonable Compensation

One caveat to this is that the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $0.01 and avoid contributing anything to Social Security and Medicare. 

So, what is “reasonable compensation”? While the terms aren’t completely defined, the IRS seems to consider “reasonable” to be something similar to what others in your field are earning for similar work.

Advantages of S Corp Status for C Corporations

If you have a C corporation (the default form of corporation), filing as an S corp does have its advantages:

Pass-Through Taxation

One big disadvantage for traditional corporations is “double taxation.” When the corporation makes money, the IRS taxes those profits on the corporate level. And when those profits are ‌distributed to the shareholders, they’re taxed a second time on the shareholders’ personal tax returns.

But when a C corporation qualifies to be an S corp, those profits are only taxed at the individual level. The business itself isn’t taxed on them. This is called “pass-through taxation.”

Writing Off Losses

Just as business profits pass through to the owners of an S corp, so do the losses. Unlike the shareholders of a C corporation, S corp owners can write off the company’s losses on their personal income statements. 

Qualified Business Income Deduction

Under the Tax Cuts and Jobs Act, some S corp owners may be able to deduct up to 20% of their qualified business income. This deduction isn’t available to C corporation shareholders.

Qualified business income (QBI) is basically your share of the company’s profits, or, as the IRS puts it, “QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts.” The IRS website has a detailed explanation as to what is and is not included in QBI. There’s an income threshold that, if exceeded, may reduce your QBI (see the IRS website for details).  

Disadvantages of S Corp Status for LLCs

LLCs with S corp status can have some drawbacks:

Stricter Requirements 

S corps have more qualifications than a standard LLC. An S corp can have no more than 100 members, and none of them can be partnerships, corporations, or non-resident aliens. A traditional LLC doesn’t have these limitations.

More IRS Scrutiny

Because of the above restrictions and the requirements about paying yourself a “reasonable salary,” the IRS monitors LLCs filing as S corps more closely. That could mean a greater chance of being audited.

Additional Accounting and Bookkeeping

Having an LLC that files as an S corporation generally means more paperwork. If you don’t already have to do payroll for your business, being an owner-employee means that you’ll have to do so. Your taxes will be more complex, as well.

Disadvantages of S Corp Status for C Corporations

S corp status also has its downsides for C corps:

Limited Number of Shareholders

As we said, an S corp can’t have more than 100 shareholders, while a C corporation has no such restriction.

Limited Types of Shareholders

All S corp shareholders must be U.S. citizens, or certain trusts or estates. That could limit your ability to expand internationally. You also can’t have partnerships or corporations as shareholders. 

One Class of Stock

One way corporations attract investors is to offer preferred stock. The IRS doesn’t allow this for S corps.

More IRS Scrutiny

Because of the extra restrictions S corps have, the IRS watches them more closely to see if they’re in compliance. Thus, your corporation is more likely to get audited.

S Corp Tax Calculator

The S Corporation tax calculator below lets you choose how much to withdraw from your business each year, and how much of it you will take as salary (with the rest being taken as a distribution.) It will then show you how much money you can save in taxes.

Disclaimer: The savings estimate provided by this tool is for informational purposes only and should not be considered financial, tax, or legal advice. Actual savings may vary depending on individual circumstances and other factors. We recommend consulting with a qualified tax or legal professional before making any decisions regarding your business entity. ZenBusiness, Inc. is not responsible for any actions taken based on the information provided by this tool. Use of this tool does not establish any client relationship with ZenBusiness, Inc.

DC and Federal Resources

While there may not be D.C.-specific resources for S corp guidance, the IRS website can provide more information on the federal guidelines of S corporations. We also recommend having a trusted tax advisor or accountant. They can help you through legal and financial challenges, helping ensure compliance and tax efficiency.

Start a DC LLC with S corp designation today

If you want to form an LLC with S corp status, our S corp service can help you do just that. Plus, we offer other services to help you run and grow your business and stay in compliance. Contact us today to get started.