What are the benefits of S Corporations?
When starting or running a business, there are multiple legal structures available to choose from. The most common are Limited Liability Company (LLC) and Corporations.
There are many benefits to incorporating, including the ability to pass on assets to future generations, shield owners from personal liability, and enjoy tax advantages.
In this article, we’ll get into the nitty-gritty of the benefits of electing to be an S corporation.
What is an S Corporation?
An S corporation is a specific type of corporation that is allowed to file a special election with the Internal Revenue Service. This election allows the company to be taxed as a pass-through entity, meaning that the company’s profits and losses are passed through to the individual shareholder’s personal income tax.
This eliminates the need for a separate tax return. It also can be beneficial for small business owners who want to minimize their tax liability.
What Are The Advantages of an S corporation?
Many entrepreneurs making a certain income level opt to become an s corporation. We’ll cover some of its best features. Here are 8 benefits of S corporations:
1) Protected Assets
S corporations offer a number of benefits to their owners. Most notably, the corporation’s assets are protected from the liabilities of the owners. This means if the corporation is sued, the owners’ personal assets cannot be seized to pay any judgments against the corporation.
In addition, S corporations offer limited liability protection to their shareholders, meaning that shareholders are not personally responsible for the debts of the corporation. This serves as liability protection.
It’s also possible to shield assets from creditors in certain cases with incorporation. If someone tries to sue you personally (instead of going after your company), having a corporate veil between you and potential litigation can be beneficial.
Finally, S corporations enjoy tax advantages over other business structures, such as C corporations, LLCs, and partnerships.
2) Income Splitting Options
Becoming an s corporation can offer huge income-splitting opportunities to employees. An S corporation can pay a salary and still distribute dividends. When taxes come due, dividends are taxed at a lower rate because it pays income tax but no self employment tax.
As a bonus, money passed down from corporations to family members via dividends or salaries isn’t subject to estate taxes when it passes down to loved ones upon death.
So, if you plan on passing along wealth to future generations, s corporations might be something worth considering.
3) Ability to Issue Stock Options
Issuing stock options allow companies to attract and retain highly skilled employees. It can also be used as a form of employee compensation. Stock options are only available to corporations, meaning S corporations can offer this benefit to their employees.
However, unlike C corporations, S corporations cannot offer common and preferred stocks. S corps must comply with the single class of stock rules and maintain ownership of 100 shareholders or less.
If an S corporation goes above 100 shareholders and offers both preferred and common stocks, the s corporation status will change from an S corporation to a C corporation.
4) No Double Taxation on Shareholders
Another benefit is that S corporations are not subject to the double taxation that C corporations are. This means that the corporation’s profits are not taxed twice, once at the corporate level and again when they are distributed to shareholders.
With an S corporation, all profits from your business pass through to your tax return and are taxed at your normal rate.
5) Treatment As A Pass-Through Entity for Tax Purposes
The greatest benefit for a small business opting to form an S corporation is its tax status as a pass-through entity.
A pass-through entity is a business entity that is not taxed itself but instead “passes through” its income and losses to the individual owners, who report them on their personal income tax returns. This means that the business itself does not pay any federal income taxes, but the owners of the business do.
6) Ability to Deduct Business Losses Against Other Sources of Income
Losses incurred by an S corporation can be used to offset other types of income for individual shareholders. If a business has a net loss reported on its Schedule K-1, shareholders can deduct those losses on their personal tax returns.
This is beneficial for small businesses that may have incurred a loss during a particular year. By being able to deduct these losses, the business can reduce its taxable income and, therefore, its tax liability.
For example, if an S corporation has $10,000 in losses for the year, shareholders can use that loss to offset their other income on their personal tax returns. This can reduce taxable income from wages or dividends.
7) Split Social Security and Medicare Taxes
When you’re self-employed, you have to pay both the employee and employer portions of Social Security and Medicare taxes. This can add up to a lot of money.
Fortunately, you can split these taxes with your business. An s corporation can help you do this without having to pay the full amount of self-employment taxes by yourself.
Think of it this way, when you are employed by someone else, your employer splits your Social Security and Medicare taxes with you. An S corporation can help you do the same thing. You pay yourself a salary, and the corporation pays half of your social security and medicare taxes while you pay the other half through payroll.
This way comes tax time, your Social Security and Medicare taxes are paid for while you still benefit from the pass-through taxation on net profits and losses.
8) Ability to Defer Taxes to Future Dates
Another benefit of forming an S corporation is that business owners can defer taxes on their profits to future dates through retirement plans. This allows business owners to save money on their taxes and save for retirement.
This is done through SEP retirement plans, which are Simplified Employee Pension (SEP) plans. The money that is saved in these accounts is not taxed until it is withdrawn, which can help business owners save money on their taxes.
What is Needed to Form an S Corporation, and How to Maintain the S Election?
To form an S corporation, the business must first file its articles of incorporation as either an LLC or a C corporation. The business owner must then complete and file IRS Form 2553.
The election must be made no later than 2 months and 15 days after the beginning of the tax year for which the election is being made.
To maintain the S election, the business must follow all IRS guidelines related to S corporations, including filing annual returns and making timely payroll tax deposits.
According to the Internal Revenue Service, an S corporation must meet and maintain the following requirements.
- Must be in the United States
- Maintain a maximum of 100 shareholders or less
- Shareholders can only be individuals, estates, and certain trusts. They cannot be partnerships, corporations, or non-resident aliens
- Must have one class of stock
- Cannot be an ineligible corporation, such as certain financial institutions, insurance companies, and corporations that does domestic international sales
Frequently Asked Questions
Can My S Corp Pay My Mortgage?
Your S corporation cannot pay your mortgage. However, you can rent a designated business space (in your home) to your S corp. You can then use that money to pay your mortgage.
For this to work, you will have to charge your business a reasonable fee, and the space must be exclusively for business use.
When Should a Business Become an S Corp?
A business owner should consider becoming an S corporation once their profits exceed a certain number. The range can be from hitting $45,000 – $65,000. It all depends on what you’ll consider a reasonable salary for the role you possess as an employee doing most of the work for your business.
As a part-time owner doing the majority of the business work, you can decide that $30,000 is reasonable where it would be worth switching to an S corp once your profits exceed that amount.
Whereas, as a full-time employee, you decide $50,000 is reasonable. The point here is that your profits exceed your reasonable salary, where you’ll have some income left over for an S election to make sense.
Do remember, S corps pays payroll taxes through the business, which means once tax time comes, you won’t be liable to pay self employment taxes.
Do S Corps Pay Taxes?
S corporations are not subject to entity-level taxation; instead, the income or losses of the S corporation pass through to the shareholders’ individual tax returns. This means that the S corporation does not pay taxes on its income, but the shareholders do pay taxes on their share of the corporation’s income.
Can I Take Distributions From My S-Corp?
Yes, you can take distributions from your S-corp. This means that you can take money out of your company as cash. For example, if you have a business and you want to take some money out to buy a new car, you can do this by taking a distribution from your company.
What is The Tax Rate on S Corp Distributions?
The tax rate on S corporation distributions depends on the recipient’s individual tax rate. Generally, distributions are taxed at the recipient’s regular income tax rate.
However, if the distribution is a return of capital, then it is not taxed. Instead, the adjusted basis of the shareholder’s stock is reduced by the amount of the distribution, that is a return of capital.
So what exactly does that mean? Well, each income level has its own income tax rate, and distributions are taxed at the tax bracket of your income level.
The only way an owner’s distribution is not taxed is if the distribution is a return of capital, which is the amount you invested in the company. Anything you receive as owner’s distribution will lower your adjusted basis until it hits zero. Once it hits zero, you will then be taxed at your ordinary tax bracket.
Do S Corps Pay Self-Employment Tax?
S corps do not have to pay self-employment tax. This is because, if done right, the business pays the business owner as if they are an employee of the company. This amount must be a reasonable salary for the position and duties the owner holds.
The business will then pay payroll taxes.
What is The S Corporation Loophole?
The S corporation loophole is a way for businesses to avoid paying certain taxes. Normally, businesses have to pay taxes on their profits. But with an S corporation, the business can split up its profits among its shareholders, who then only have to pay taxes on their individual share of the profits. This can save the business a lot of money in taxes.
You can take advantage of the S corp loopholes by
- Paying all business expenses through the business
- Putting yourself on a reasonable salary and then take owner’s distributions when necessary
- If you work from home, rent out a section of your home as an office space to your business
- Have your business pay certain fringe benefits you would have paid otherwise by yourself
How Do I Pay Payroll Taxes Through My S Corporation?
You can set up payroll taxes by hiring a Tax Professional or by signing up with a payroll company, such as ADP and Gusto.
Once you set up your payroll, you can have your Accountant, Tax Practitioner, or Payroll Representative do the work for you for a fee. The fee will be tax deductible to your business.
An S corporation is a type of business that offers many benefits for its owners and employees. These include the ability to pass through income and expenses to shareholders, limited liability, and the avoidance of double taxation.