The first real tax structure is the S-corporation. It is not a different kind of company — it is a tax election, made on Form 2553, available to an LLC or a corporation that meets the eligibility rules. Its purpose is narrow and powerful: it splits the owner’s income into two streams that the payroll-tax system treats differently.
The owner is an employee of their own company and draws a salary, subject to the same 15.3% in Social Security and Medicare taxes — now split, on paper, between the employee and the corporation.
Profit beyond the salary is distributed to the owner as a return on the business. Distributions carry no self-employment or payroll tax.
The distribution stream is where the saving lives. Every dollar moved from salary to distribution escapes the 2.9% Medicare tax, and — to the extent salary stays below the Social Security wage base — the 12.4% Social Security tax as well. There is no equivalent move available to a sole proprietor.
Eligibility restrictions. S-corporation status is not available to every business. The corporation may have no more than 100 shareholders, all of whom must be US citizens or resident aliens (not nonresident aliens), individuals, certain trusts, or estates — partnerships, multi-member LLCs, C-corporations, and most foreign owners are ineligible shareholders. The corporation may have only one class of stock, though differences in voting rights are permitted. A founder with a non-citizen spouse holding the stock as community property should verify the spouse’s residency status before electing; a founder planning to bring on a VC or a family trust should verify trust eligibility before signing. A single ineligible shareholder on a single day terminates the S election, with no automatic relief.