Since there is a lot of misunderstanding and false information floating around online about S-Corporations, I’d like to take a few moments to clarify the topic and talk about the pros, cons, and prerequisites for making the election.
What is an S-Crop?
An S-Corporation is a small business corporation. The S-Corp election allows the owner(s)/shareholder(s) to only be taxed at the individual level instead of at both the corporate and individual level. We’ll go over an example of this below.
Benefits
- Pass-through taxes are a major benefit for businesses that elect to be treated as S-Corps. If your business operates under a tax system known as “pass-through,” it will not be subject to corporate income tax. This money can be given to the shareholders or owners instead.
- Owners’ and shareholders’ restricted liability is another major perk. In the event that your business is sued or dissolved, your personal assets will be protected to a greater extent.
- Offering stock to the public is a great way to bring in capital that can be put toward expanding your firm.
- In the event of the owner’s departure, retirement, or death, the company will carry on as usual.
- Reduces self-employment taxes.
Demerits
- There is more red tape and costs associated with this. Articles of Incorporation must be filed with the state, a registered agent must be appointed, and fees must be paid in order to officially form a corporation. Annual report or franchise tax fees are examples of the types of recurring costs levied by many states. These costs are usually not very high, and the money you save on taxes more than makes up for them.
- Since distributions to shareholders are permitted by having an S-Corp classification, the IRS will check to see that the payments are properly classified.
- The IRS will cancel the company’s tax status, assess back-taxes for three years, and impose a five-year waiting period if a non-resident stockholder or stock is transferred into the corporate entity’s name.
- In order to avoid payroll taxes, S-corp owners must pay themselves a “reasonable salary” as employees. This required running payroll
- Additional cost of filing a separate S crop tax return.
How much will I save as on S-Crop?
Determine potential tax savings from making the S-Corp election using the tool provided below. Because of these one-time charges, the total amount saved in the first year will be less than the annual average continuing forward.
What is Pass-Through Taxation?
As an illustration of S-Corporation pass-through taxation, consider the following:
John,LLC (Owner John) is a successful IT consulting company that brings in over $150000 annually. John has decided to have her John, LLC be treated as a S Corporation, so he may have taxation advantages. John is the sole employer & employee of John,LLC and John, LLC pays him $100,000. The remaining $50,000 in profits are distributed to John as S corporation profit rather than employee wage on his personal tax return. John and his business can keep the $50,000 in earnings without having to pay Social Security or Medicare on it. Employment taxes for Sarah and her business are merely $15,300 (15.3% x $100,000). The remaining $50,000 profit from John,LLC S-corporation will be subject to ordinary income tax. John would have been responsible for paying self-employment tax and income tax on the entire $150,000 profit if he hadn’t elected S corporation status for his LLC. He would have owed an extra $22,950 ( 15.3% x 150,000)
| Estimated tax saving | ||
| Business Structure | Sole Proprietor | S-Crop |
| Yearly Income | $150000.00 | $150000.00 |
| Less: Reasonable Salary (See below) | $100,000.00 | |
| Self Employment tax | ||
| Social Security Tax (12.4%) | $18,600 | $12,400 |
| Medicare Tax (2.9%) | $4,350 | $2,900 |
| Total Self Employment tax | $22,500 | $15,300 |
| Saving | $7,200 | |
When Should You Form an S-Corporation for Your Company?
The first step in the incorporation process for any company is to determine whether it will be a C Corp or a single-member LLC. After that is done, an S-Corp election must be filed and all S-Corp requirements must be met.
If your answer to below questions are YES, then your LLC can elect an S Crop election.
- Is your company currently registered with a state as a domestic corporation (e.g. LLC)?
- Does your company have less than 100 shareholders (owners)?
- Are all of your shareholders U.S. citizens or resident aliens?
- Do all of your shareholders agree to the S-Corp election?
- Can you pay the shareholder/employees a reasonable salary for their position?
- Do you only have one class of stock?
How Much Should an S-Corporation Be Paid?
When deciding how much money an owner or shareholder should get, there are a few things to keep in mind.
- Skills and experience of the worker.
- The character, breadth, and depth of the worker’s responsibilities.
- The scope and intricacy of the company.
- A breakdown of the company’s salary costs vs its gross and net income.
- The state of the economy as a whole currently.
- Wages are weighed against shareholder dividends to see how they stack up.
- Current market salary levels for similar roles.
- The taxpayer’s salary structure for all workers.
- The sum total of a worker’s salary from prior years.
There is no clear guideline from the IRS. The U.S. Bureau of Labor Statistics compiles comprehensive wage data searchable by occupation nationwide, in addition to comparable wages by state, region, and city.
How Do I Apply for S-Corp Status?
- Pick a name for legal use, and set it aside. You can file a name reservation with the Secretary of State in many states.
- Write up some Articles of Incorporation and get them filed.
- Corporate bylaws are a summary of the rules governing the company’s activities, officer roles, and obligations and should be prepared if instructed to do so by your small business attorney. Document all board and shareholder meetings in the company’s official minutes.
- Issue stock certificates to the founding investors.
- Prepare an IRS Form SS-4 to apply for an EIN (Employer Identification Number).
- There may be state and municipal licenses your new corporation needs in order to function legally. Within 75 days after your corporation’s creation, file IRS Form 2553.
Do you need our service?
We’ve assisted many small business owners across the United States in achieving an S-Corp status, and we’d love to assist you as well. Contact Surya Padhi at Sure Financials for any question and clarification. Surya Padhi is an expert who keeps current on tax law changes as well as a member of the National Association of Tax Professionals National Association of Tax Professionals (NATP) and New Homepage – National Association of Enrolled Agents (naea.org). Visit Welcome | Sure Financials & Tax Services, LLC (surefintaxsvs.com) for more information and contact us by calling +1908.955.0696.
