S-Corporation: Is it Right For My Business?
What is an S-Corporation?
There is a misconception that an S-Corporation is a standalone entity. Not true. An S-Corporation is the result of a tax election on an existing entity with the primary purpose of reducing self employment taxes or double taxation (C corporation). This means you will need to have an existing entity that can be taxed as an S-Corporation. There are three basic business entities that can be taxed as an S-Corporation:
Limited Liability Company (LLC) - single member or multi-member
Limited Liability Partnership (LLP) or General Partnership (GP
C Corporation including Professional Corporation
Notably missing from the list is sole proprietors because they are not an entity nor is the variant “Doing Business As” (DBA). Also note how an S-Corporation is not listed. It is not an entity. It is a taxation election. The underlying entity has to be one of the above, and usually it is an LLC (either single-member or multi-member) for the ease of formation yet corporations and professional corporations are common as well. Not an LLC yet? Let us help!
So, if asked what kind of entity you have after electing S-Corparation status you would say “ I have an LLC (or Corporation or Partnership) taxed as an S-Corporation.
The S-Corporation tax election creates pass-through taxation where the business entity doesn’t pay federal income tax but rather the profit/loss of the business entity is “passed through” to the owner(s)/shareholder(s) personal tax return where the federal income tax is paid.
Advantages of an S-Corporation
TAX SAVINGS in the form of reduced self-employment taxes (Social Security and Medicare). See S-Corporation Tax Savings article.
Pass through taxation. The owner(s)/shareholder(s) are only taxed at the individual level instead of at both the corporate and individual level. (Dependent on shareholder personal tax bracket rate)
Tax free distributions (with sufficient basis in the S-Corporation).
Lower rate of audit. However, this is changing with increased reporting on shareholder basis (loss deductibility and taxability of distributions) and reasonable salary (avoding self-employment taxes)
Disadvantages of an S-Corporation
Increased accounting/tax costs. An S-Corporation has a separate Federal Income Tax Return Form 1120-S that has to be filed annually. Also, the owner becomes an employee of the S-Corporation and a payroll system will need to be used to create paychecks, pay payroll taxes, file payroll tax forms, etc.
Additional FUTA payroll taxes of approximately $400. This increased tax is typically offset by the reduced self-employment taxes.
State business taxes. Some state have specific taxes on S-Corporations.
Shareholder basis issues that disallow losses being taken on the individual tax return. See article on basis in S-Corporations.
Multiple partners with unequal revenue splitting. Shareholder distributions must be made on pro-rata basis of ownership.
Does my business QUALIFY to be an S-Corporation?
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YES - Your company must be registered as a LLC, Corporation or Partnership with the State.
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YES - Your company must have less than 100 shareholders.
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YES - All shareholders must be U.S. Citizens.
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YES - All shareholders must agree.
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YES - A reasonable salary must be paid.
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If your company is publicly held, yo ucan only have one class of stock.
SHOULD my business become an S-Corporation?
Due to misinformation on the internet about S-Corporations, there can be confusion around when it makes sense to elect S-Corporation status. Below are some questions to consider when deciding if the election makes sense for your business.
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You can’t go back and forth between years on the S-Corporation election. If you elect S-Corporation status, you should be prepared to run it as such for several years. If you dissolve the S-Corporation status, you can’t elect it again for 5 years. It is costly to elect and dissolve S-Corporation status, so you want to make sure you are able to recover those costs in the form of tax savings over several years.
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There are additional accounting and tax costs associated with running an S-Corporation, so you want to make sure that that the tax savings offset the additonal costs to operate the business. There is no magic number as it will depend on the what the costs are for your specific business. If you want to find out more on what the costs might look for your business and what profit level makes sense to elect S-Corporation status, please contact me.
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In conjunction with the question above, you want to asses your profit levels in the future to make sure the tax savings outweigh the additional costs of operating the S-Corporation .
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The easiest is when there is only one owner (and a spouse). If there are multiple shareholders, then it is key to have revenue splitting based on ownership percentages. If it split in some other manner, you will need to explore a multi-entity arrangement. Please contact us if you need more information regarding a multi-entity arrangement.
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S-Corporations aren’t ideal tax wise for real property that appreciates in value.
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If the business has a large amount of debt (loans, credit cards)without corresponding levels of assets (cash, accounts receivable, fixed assets etc.), this can create a basis/equity issue that leads to losses being disallowed on the shareholder’s personal tax return and the potential for tax free distributons to be taxed. Pleas review the article on S-Corporation Basis.
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As discussed above, it key to have sufficent equity in the business to maintain tax free distributions and pass-through losses being tax deductible.
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Some States charge high S-Corporation tax rates that eat up all of the federal tax savging. Examples: New York City, Tennesse, New Hapshire
How do I make the S-Corporation Election?
We’ve assisted many small business owners across the United States make the S-Corporation election and help with the ongoing activities of the S-Corporation (payroll processing, payroll tax filings, Form 1120S prepartion, etc. )
Please contact us if you have questions on making the switch. Below is our standard S-Corporation election package. We also offer payroll and tax preparation services for the ongoing running of your S-Corporation.
S-Corporation Election Package
$900 (One time fee)
40 Minute Consultation
One-on-one phone call to discuss the S-Corporation process and determine if it's the best fit for your business.S-Corp Election Form
An S-Corp election form will be prepared for you. Once the form has been prepared and reviewed we will file the form with the IRS.Federal Tax ID Number (EIN)
A Federal Tax ID Number is used to identify a business entity and will be used to open your business bank account and hiring employees.Payroll Setup
As an employee of the S-Corporation you will need to be on payroll. We will set up a Quickbooks payroll account for you and your employees (if applicable)S-Corp Accountable Plan
You will be provided with an accountable plan template and instructions. An accountable plan follows IRS regulations for reimbursing workers for business expenses in which reimbursement is not counted as income (home office, mileage, business use of cell phone, etc.). This means that reimbursements are not subject to withholding taxes or W-2 reporting.