Basics of S Corporation Taxation
An S corporation (S Corp) is a special kind of corporation which operates as a corporation but is taxed on the individual shareholders’ tax forms, for federal income tax purposes. In order to become an S corporation, a business must meet some specific requirements and then must file an election form with the IRS. For tax purposes, an S corporation is considered a pass-through taxing mechanism. That is, the tax on the S corporation is passed through to the owners for federal income tax purposes.
- The main benefit of incorporating as an S Corporation over being self-employed is the tax savings on self-employment taxes (Social Security and Medicare). For each dollar of profit, it could mean over 14% in tax savings.
S Corp Tax Saving Strategies
- Reduction of Owner’s Salary: By cutting their salaries by $10,000 to $20,000 a year, S corp owners can reduce their payroll taxes. This way, they can take the residual S corp revenue in distributions exempt from self-employment tax without reducing their pay further.
Tax Benefits and Legislation
- An S corporation pays the same taxes as other businesses, including employment taxes on employee pay, reporting federal and state income taxes, paying and reporting FICA (Social Security and Medicare) taxes, worker’s compensation taxes, and unemployment taxes.
Making the Most out of S Corp Tax Savings
- For aspiring start-ups, S corp tax savings lets you better reinvest finances and accelerate growth. By dispersing the money as salary or dividend, you lower your liability for self-employment tax. Let’s understand this further by breaking the tax benefits of S-corporation into three; double taxation, self-employment tax, and health premiums.
Conclusion and Additional Considerations
- To make things more complicated, you can even request S Corp status for an LLC! Talk to your accountant or tax advisor to understand the options and make the smartest choice for your business.
S Corporation Profit and Loss
- If an S corp has sales but breaks even every year, what values are on my personal return and tax transcript? $100,000 in sales (income) with $100,000 in expenses equals $0 ordinary income (loss) on your Form 1120-S and Schedule K-1; it is a wash. Tracking your shareholder basis may enable you to determine how your gains and losses from a K-1 are reported on your 1040 return. Regardless of how tedious the tracking could be for certain shareholders; the basis should be updated annually and tracked by the shareholder.