S Corporation Fact Sheet

Saving Business Taxes with an S Corporation: A Short Primer

S corporations, or Sub chapter S corporations, produce several tax benefits as compared to sole proprietorships, partnerships, and C corporations.

The big benefit--and the one that people usually talk about--is the payroll tax savings.

To understand how this works, let me compare two alternatives: A sole proprietor making $90,000 a year and an S Corporation making $90,000 a year.

Of course, the taxes that a sole proprietor pays depends on his or her filing status, itemized deductions and family size, but typically such a person might pay about $12,000 in federal income taxes. The person might also pay another chunk in state income taxes.
In addition to these income taxes, the proprietor also pays a 15.3% self-employment tax on the $90,000 of business profits. Roughly, this self-employment tax (which is equivalent to Social security and Medicare tax) equals $13,000.

Things usually work differently for the S corporation, however. To make calculations easy, assume the S corporation is owned by a single shareholder. In this case, the S corporation must break the $90,000 of profit into two buckets: wages and the leftover (which is called a distributive share). If the wages equal $40,000 and the leftover distributive share equals $50,000, the business pays Social Security and Medicare taxes (equivalent to self-employment tax) equal to roughly $6,000.

In this case, even though the two businesses make the exact same amount of money, the S corporation pays roughly $7,000 less in tax each year.

By the way, in addition to the big benefit of self-employment tax reduction, S Corporations also provide two other useful benefits--benefits which are a little more difficult to quantify but still important nonetheless.

One such benefit is that S corporation losses (such as those that often occur in the early start-up years) can be used as tax deductions on the shareholder's personal income tax returns.
Another such benefit is that the S corporation isn't taxed on S corporation profits--at least by the federal government.

Once you've made the decision to structure your business as a corporation (most likely for the liability protection a corporation offers), you still have a decision to make: Will you form a C Corporation or an S Corporation?

Tax concerns often play a major role in this decision. Like the partnership business structure, S Corporations do not pay any federal income taxes. Instead, the business's profits and losses are passed through to the shareholders, who must then report the income and losses on their personal tax returns. Referred to as "single taxation," this process differs from C Corporations, which face "double taxation." That means C Corporations pay federal income tax, and any dividends paid to shareholders are taxed as well.

Although tax concerns are important, they don't tell the whole story. The advantages of forming an S 

Corporation include:
 

• Eliminating double taxation: In an S corporation, profits and losses are passed through to shareholders, and taxes are only paid once. Check with your state to see how it handles S Corporations. Some states do not recognize S Corporations and will tax such businesses as a regular C Corporation. Some states charge S Corporations a state tax, although the corporation will not have to pay federal tax. 
• Protection from liability: As the owner of an S Corporation, your personal assets are separate from the business's assets and are therefore protected in case any judgments occur against the business.
• More room for investors: S Corporations can have up to 100 shareholders.
• Easier accounting rules: S Corporations without any inventory can use the cash method of accounting, which is much simpler than the accrual method. Check with your accountant about which option makes sense for your business.

Here are some disadvantages of forming an S Corporation:

• Rules and fees: Like a C Corporation, S Corporations are required to file a number of official state and federal documents, including Articles of Incorporation and corporate minutes. They must also hold regular shareholder meetings and pay the required government fees.
• Shareholder restrictions: Realize that if an S Corporation has shareholders, the shareholders will be taxed for any income the company has, even if they did not receive any portion of that income. (In a C Corporation, shareholders are taxed only if they receive dividends.) In addition, S Corporations are only allowed to issue one class of stock, which may discourage some investors.
• Salary requirements: The Internal Revenue Service requires all officers and owners of an S Corporation to make a salary, even if the company is not yet making a profit. This could be problematic for new businesses struggling to make payroll. A "reasonable salary" is what a person with the appropriate skills needed for the position would be paid on the free market.

Source: all business.com

“You must pay taxes. But there’s no law that says you gotta leave a tip.”  can’t quite remember who said it but I sure remember the quote.

S Corporations are a no brainer.

1. The most popular form of business structure in America today.  60% of all corporation tax returns filed this year are S Corporations.
2. Limited liability.
3. Limited IRS exposure.
4. Significant tax savings.

Now that you are incorporated there are three things you absolutely must do....or risk IRS problems

1. Open a corporate checking account. Paying all corporate (business) bills from that checking account.
2. Avoid paying any personal bills from that checking account.
3. Pay yourself a salary.  Mainly used to pay your personal income tax salary. The John Edwards tax loophole.

Donald C. Fuener E.A.

S Corporation Fact Sheet updated December 19, 2012