Form a Wisconsin S Corp

Embarking on the process of designating your business as an S corporation in Wisconsin can open the door to valuable tax advantages. An S corp, defined by its tax classification under Subchapter S of the Internal Revenue Code, allows a business’s profits and losses to pass directly to its shareholders, thus avoiding the double taxation often associated with C corporations. This introduction aims to guide you through the steps necessary for obtaining S corp status in Wisconsin, emphasizing the tax benefits and key considerations for businesses in the state.

For entrepreneurs operating a limited liability company (LLC) in Wisconsin, electing S corp status can be particularly beneficial in terms of self-employment tax savings. This tax strategy enables LLC members to potentially reduce their self-employment tax liability by categorizing a portion of the business’s income as salary and the remainder as distributions, which are then not subject to self-employment taxes. As we delve into the specifics of securing S corp status in Wisconsin, we’ll highlight the eligibility criteria, required filings, and the operational implications to help ensure your business is poised to take advantage of the tax efficiencies offered by this election.

Requirements and Limitations of S Corporations

There are a few Wisconsin S corp filing requirements and limitations you should be aware of before you begin this process. (These are actually federal requirements from the Internal Revenue Code, not specific to Wisconsin.) 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 members or shareholders, 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.

If your business entity meets these requirements, applying for an S corp election could be a tax option for you.

Filing as an S Corp in Wisconsin

To create a Wisconsin 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 Internal Revenue Service (IRS).

Wisconsin-Specific Considerations

In an S corp, the business itself doesn’t usually pay tax on income at the federal level. But what about Wisconsin income tax and other state taxes?

A Wisconsin business that files as an S corp at the federal level is usually automatically taxed the same way at the state level, meaning that the business itself wouldn’t pay Wisconsin income tax, just the business owners. For Wisconsin tax purposes, the profits would be taxed as they would at the federal level. However, a Wisconsin S corporation may still have to pay taxes (specifically, the franchise tax) on interest income.

Some states do require the S corporation to file an additional form to make the S corp election at the state level, but not Wisconsin. At tax time, however, an S corp may have to file a Wisconsin S corp return (Form 5S).

Opting Out of Wisconsin S Corp Election

Recently, Wisconsin enacted Senate Bill 883 to give the owners of pass-through entities like S corporations the option to be taxed at the entity level for Wisconsin taxes for the taxable years beginning in 2019. In those cases, the Wisconsin S corp tax rate would apply. But why would an S corporation want to do that or pay state corporate income tax?

Well, previously, individuals weren’t limited as to what they could deduct for state income tax. But the Tax Cuts and Jobs Act of 2017 limited those deductions to $10,000 annually, which is known as the “SALT Cap.” (SALT is an acronym for state and local taxes.) But if the business is taxed at the entity level, the SALT Cap no longer applies. Wisconsin is one of several states that have recently enacted legislation related to this cap.

Taking this option isn’t necessarily going to mean tax savings for every business, though. Talk to a tax advisor to see if it would benefit you.

Economic Development Surcharge

If your S corp has $4 million or more in gross receipts, it will be subject to the Wisconsin economic development surcharge. The Wisconsin S corp tax rate for the economic development surcharge is $25 or 0.2% of net business income, whichever is greater, but not more than $9,800.

To get a Wisconsin S corp, you’ll need to create either an LLC or a C corporation (the default form of corporation) if you haven’t already done so. Then, you’ll file an election form with the IRS.

S-Corp Election Steps for LLCs

For detailed formation steps, see our Wisconsin LLC formation guide.

• Step 1 – Choose a name
• Step 2 – Choose a registered agent
• Step 3 – File Wisconsin Articles of Organization
• Step 4 – Create an operating agreement
• Step 5 – Apply for an EIN
• Step 6 – Apply for S Corp status with IRS Form 2553

S-Corp Election Steps for Corporations

For detailed formation steps, see our Wisconsin Corporation formation guide.

• Step 1 – Name Your Wisconsin Corporation
• Step 2 – Appoint Directors
• Step 3 – Choose a Wisconsin Registered Agent
• Step 4 – File the Wisconsin Articles of Incorporation
• Step 5 – Create Corporate Bylaws
• Step 6 – Draft a Shareholder Agreement
• Step 7 – Issue Shares of Stock
• Step 8 – Apply for Necessary Business Permits or Licenses
• Step 9 – File for an EIN and Review Tax Requirements
• Step 10 – Submit Your Corporation’s First Report
• Step 11 – Apply for S Corp status with IRS Form 2553

File form to apply for S Corp status

Submit the form to apply for S corporation status. Once the state approves your LLC or C corporation formation, you need to file Form 2553, Election by a Small Business Corporation, with the IRS to get S corporation status. 

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

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

OR

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

One additional note for LLCs wishing to file as an S corporation: 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. 

All of the individual 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.

Pros and Cons of Filing as an S Corp

While S corp classification does come with a number of benefits for some businesses, making this election isn’t necessarily right for all business types. So, be sure to carefully evaluate the pros and cons before deciding how you want to move forward. Consult an accountant about whether the S corporation election would be best for your business.

Advantages of S Corp Tax Designation for LLCs

The advantages of filing as an S corporation for an LLC differ from the advantages for C corporations. Let’s look at the advantages for LLCs first.

A traditional LLC already has pass-through income taxation by default, so the benefits of S corp election for an LLC have to do with self-employment taxes. This takes some explanation, but for certain LLCs, it could save a lot in taxes.

An Explanation of Self-Employment Taxes

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 actually be employees of the LLC. Being self-employed means they would pay tax for self-employment (the tax that goes toward 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 part 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 taxes and all other applicable taxes on their share of the profits.) Money paid out as salary is a tax-deductible expense for the business. 

Reasonable Compensation

One important 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 $1 and avoid contributing anything to Social Security and Medicare. 

That begs the question, what is “reasonable compensation”? The instructions on Form 1120-S read, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.” 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.

If the IRS decides that your salary isn’t reasonable, it has the authority to reclassify your non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes). The courts have supported the IRS’s right to do this.

Advantages of S Corporation 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. But when those profits are ‌distributed to the individual owner (corporation shareholder) as dividends, they’re taxed a second time on the shareholder’s personal income tax return. The government takes a cut twice.

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,” and it’s how business entities like a sole proprietorship or general partnership are taxed. LLCs are also taxed this way unless they choose to be taxed as a C corporation.

We need to add here that, since the 2017 Tax Cuts and Jobs Act, the corporate tax rate has been lowered to a flat 21%. So, the disadvantages of double taxation aren’t as severe now as they had been. 

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 business’s losses on their personal income tax statements. 

This can help offset their income from other sources and can be helpful if the corporation loses money in its initial years of business. Still, make sure you’re aware of ​​the IRS’s shareholder loss limitations.

Qualified Business Income Deduction

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

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 a taxable income threshold that, if exceeded, could reduce your QBI (see the IRS website for details).  

Disadvantages of S Corporation Status for LLCs

Having an LLC with S corporation status can also have some drawbacks over a traditional LLC:

Stricter Requirements 

As we listed above, S corps have more qualifications than a standard LLC or C corporation. 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 tends to monitor LLCs filing as S corps more closely. That could mean a greater chance of being audited, even if you follow the law to the letter. In fact, S corp owners may want to observe some of the same formalities that C corporations do (such as extensive record keeping), even if they’re not legally required to.

Additional Accounting and Bookkeeping

Having an LLC that files as an S corporation usually 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.

With these added factors, you’re likely to have higher administrative costs. You may find that you need an accountant, bookkeeper, and/or a payroll service or software.

Disadvantages of S Corporation Status for C Corporations

S corp status also has its downsides:

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. That limitation could be an issue later if the corporation grows and goes public.

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. C corporations don’t have such limitations.

One Class of Stock

One way corporations attract investors is to offer preferred stock. That’s allowed for C corporations, but not 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. In other words, your corporation has a greater chance of being audited.

It’s extremely important it is to have tax guidance about your specific situation from a qualified tax professional. An accountant with S corp experience should be able to make sure you stay in compliance with the IRS, but they may also be able to help you find additional tax savings.

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.

Get help establishing a Wisconsin LLC with S corp tax election

As you might guess from this article, forming a business can be complicated. Fortunately, we’re here to cut through the red tape and make it as easy for you as possible.

When you’re ready to take the next step, we can help you form a Wisconsin LLC with an S corporation designation and provide you with valuable support for all of your business needs moving forward.