Form a Maryland S Corp

Embarking on the establishment of an S corporation in Maryland presents a strategic opportunity for business owners aiming for optimal tax benefits. An S corp, designated under Subchapter S of the Internal Revenue Code, is specifically a tax election that enables businesses to pass income directly to shareholders, thereby sidestepping the double taxation often associated with C corporations. This tax status can be particularly advantageous for Maryland’s limited liability company (LLC) owners, as it provides a pathway to potential savings on self-employment taxes. By electing S corp status, LLCs can benefit from the differentiation between salary and profit distributions, with self-employment taxes applied only to the salary.

This guide is crafted to explore the intricacies of initiating an S corp in Maryland, highlighting the process, benefits, and critical considerations to empower your business to make the most of the tax efficiencies inherent in this designation.

Maryland S Corporation Filing Requirements

For the IRS to accept your application for S corp election, you must meet the filing requirements of the Internal Revenue Code. Specifically, to qualify for S corporation status, an entity must:

• Be a domestic LLC or corporation
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations
• Only have 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/members 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 election. However, if your business entity falls within these parameters, you can apply for an S corp election. 

Considerations for Maryland S Corp Taxes

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

S corporations in Maryland must file Maryland Form 510, Pass-Through Entity Income Tax Return, if the business is formed or incorporated in Maryland, does business in Maryland, or has Maryland income or losses. Each S corp member then has to file the applicable Maryland income tax return and pay any tax due on the member’s distributable or pro-rata share of the pass-through entity’s items for the tax year.

You don’t need to pay Maryland income tax with Form 510 unless you’re subject to the nonresident member tax. If your S corp has a nonresident member and any nonresident taxable income, then the business is subject to the Maryland income tax. The S corp is taxed on the nonresident taxable income, which is the total of the nonresident members’ distributive or pro-rata shares of the S corp’s income allocable to Maryland.

How to Form an S Corp in Maryland

To start a Maryland 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 Maryland LLC

1. Name your Maryland LLC
2. Appoint a resident agent in Maryland
3. File Maryland 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 Maryland LLC” page.

Forming a Corporation in Maryland

1. Name your Maryland corporation
2. Appoint Directors
3. Choose a Maryland Statutory Agent
4. File the Maryland 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 Maryland corporation, follow the instructions on our Maryland corporation page.

File form 2553 to apply for S corp status

When 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

Whether your S corp is an LLC or a corporation, you must file an annual report. Most LLCs and corporations have to pay a $300 filing fee. Only three entities are exempt:

• Foreign non-stock corporations
• Domestic non-stock corporations
• Foreign interstate corporations

Additionally, corporations have to fill out a separate section of their annual report. Section II provides the names and mailing addresses of all corporate officers and corporate directors. A corporation with S corp election must also hold an annual meeting of its stockholders to elect directors and transact any other business within its powers, just as any Maryland corporation would.

Pros and Cons of S Corp Election for Maryland Corporations

While S corp status does come with a number of benefits for some businesses, making this election might not be right for everyone. Carefully weigh the pros and cons before deciding how you want to proceed. 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 come from 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 double 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 employed by the LLC. Once they do that, they only pay taxes for Social Security and Medicare 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 provision 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 $0.03 and avoid contributing anything to Social Security and Medicare. 

So, what is “reasonable compensation”? While the terms aren’t 100% 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 has these 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 business level on a corporation income tax return. 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 company’s losses. Unlike the shareholders of a C corporation, S corp owners can write off the business’s losses on their personal income statements. 

Qualified Business Income Deduction

Under the 2017 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 drawbacks, though:

Stricter Requirements 

S corps have more qualifying conditions 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.

Extra IRS Scrutiny

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

More 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 start. 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 corporations or partnerships as shareholders. 

One Class of Stock

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

More IRS Scrutiny

Because of the extra limitations 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.

Maryland and Federal Resources 

For more information about how S corps and other pass-through entities are treated in Maryland and other important tax information, see the Maryland State Comptroller website. The IRS website can also provide more information on the federal guidelines for S corporations. We recommend having a trusted tax advisor or accountant. They can help you through legal and financial challenges, helping ensure compliance and tax efficiency.

Recommended article: Form a DC S Corp

Get help establishing a Maryland LLC with S corp tax election

Are you ready to form an LLC with an S corp election? Our S corp service can help you do that. Plus, we offer other services to help you run and grow your business and stay in compliance. Contact us today to get started and make your dream business a reality.