The S Corp Confusion: Why "S Corp" Doesn't Mean What You Think It Means

Here's something that might surprise you: there's no such thing as an "S corp" business entity.

If you've ever said "I'm forming an S corp" or felt overwhelmed by conflicting advice about business structures, you're not alone. This confusion trips up thousands of entrepreneurs every year.

The Mix-Up That's Confusing Everyone

Here's what's happening: When most people say "S corp," they're unknowingly mashing together two completely different business decisions.

Starting a business actually requires two separate choices:

1. What type of business do you want to legally create? (Your entity structure, which gets filed the state’s Secretary of State)

2. How do you want the IRS to tax that business? (Your tax classification)

An "S corp" is only the second choice - it's a tax treatment, not a business type.

What's Really Happening When Someone Says "I Have an S Corp"

Let me decode this for you. When someone says they "have an S corp," here's what actually happened:

1. They formed a real business entity (usually an LLC or corporation)

2. They filed a form with the IRS requesting "S corporation tax treatment"

3. Now they have a business that's legally one thing but taxed like another

4. They started using "S corp" as shorthand, creating confusion for everyone

The Real Business Entities You Can Actually Form

When you're ready to make your business official, you're choosing from these actual entity types:

LLC (Limited Liability Company): The Swiss Army knife of business structures. Flexible, simple, protects your personal assets. Most small businesses end up here.

Corporation: The formal option with shareholders, boards of directors, and corporate bylaws. Think "business suit required" level of structure.

Partnership: Multiple owners sharing the business like roommates sharing an apartment. Great when it works, messy when it doesn't.

Sole Proprietorship: Flying solo with no legal separation between you and your business. Simple but risky.

The Tax Menu: How Your Business Can Be Taxed

Once you've picked your entity, you get to choose from the tax menu:

Pass-through taxation: Business profits flow directly to your personal tax return. No double taxation, but you might pay self-employment taxes.

Corporate taxation: The business pays its own taxes, then you pay taxes again on any money you take out. Sounds terrible, but sometimes it's actually cheaper.

S corporation taxation: The special sauce that gets everyone excited. Profits flow through to you personally, but you can potentially save on self-employment taxes.

Why Everyone's Obsessed with S Corp Tax Treatment

Here's why "S corp taxation" gets so much attention: it can save you money in self-employment taxes.

Let's say your business makes $100,000 profit. Under normal pass-through taxation, you'd pay self-employment tax on the full amount. With S corp taxation, you pay yourself a "reasonable salary" (let's say $60,000), pay employment taxes on that, and take the remaining $40,000 as a distribution that's not subject to self-employment tax.

The potential savings are real, but there's a catch: you have to actually run payroll for yourself, file additional tax forms, and meet IRS requirements. It's not free money - it's a trade-off between potential tax benefits and administrative complexity.

280E also affects this, so make sure you work with an accountant who understands taxation of cannabis businesses.

When This Confusion Creates Problems

The Mismatched Expectations Problem: Jake and friends wanted to "form an S corp" for their cultivation business. They filed as a corporation with the state, thinking that S corp meant corporation. They used an online LLC operating agreement template because that seemed easiest. When they got into a dispute about the business, they had a mess that cost them a lot of money to have a lawyer straighten out.

The Investor Nightmare: Maria told potential investors in her marijuana business that she had an "S corp" but actually had an LLC with S corp tax election. When it came time to accept investment, she discovered that LLCs and corporations have completely different rules for adding new owners. The miscommunication created confusion during negotiations.

The State Registration Mix-Up: David tried to register his "S corp" with his state, only to learn that states don't recognize S corp elections - they only see your actual entity type. He'd been planning his business around the wrong legal structure entirely.

The Smart Way to Think About Your Business Structure

Stop asking "Should I form an S corp?" Instead, ask these two separate questions:

Question 1: What legal structure makes sense for my business?

• How many owners will you have?

• Do you want maximum flexibility or formal corporate structure?

• What are your state's specific requirements and fees?

• How do you plan to grow and potentially exit?

Question 2: How should my business be taxed?

• What's your expected income level?

• Do you want to minimize self-employment taxes?

• How complex are you willing to make your tax situation?

The Plot Twist: You Can Change Your Mind

Here's something most people don't realize: you can change your tax election without changing your entity type.

Started with an LLC and simple taxation? You can elect S corp treatment later when your income makes it worthwhile. Formed a corporation but S corp taxation isn't working out? You can switch to C corp taxation or even dissolve and reform as an LLC.

Your entity choice is harder to change, but your tax election can evolve with your business.

Your Next Steps (Without the Confusion)

Before you do anything:

1. Talk to professionals who understand the distinction: Find an accountant and lawyer who distinguish between entity types and tax elections

2. Start simple and evolve: Most businesses begin as single-member LLCs with default taxation, then elect S corp treatment when it makes sense

The Real Bottom Line

"S corp" isn't a type of business - it's a tax strategy you can apply to your business. Understanding this distinction helps prevent confusion, gives you clarity when talking to professionals, and provides the flexibility to optimize your structure as your business grows.