Tax filing due dates vary depending on how you’re structured as a business or company. For S-Corp businesses, March 15th is the magic filing date.
But, what is an S Corp tax structure and how do you know if you should form one?
What are the benefits or drawbacks of an S Corp tax structure?
Suppose you choose to pass the income, loss, credits, and deductions to your shareholders. In that case, you have to create an S Corp. By doing so, you will be classified as a specific tax status that allows you limited liability.
In return, shareholders are obliged to include any financial movements from the S-Corp on their personal tax returns to be assessed for individual taxes. However, S Corporations are not free from the IRS since they must also pay taxes on employment, excise, capital gains, passive income, etc.
Both S Corp and LLC are considered limited liability companies. But the primary difference is the former could not have more than 100 shareholders who must be U.S. citizens/residents.
Tax Benefits of Forming an S Corp
Any bookkeeper will tell you that an S Corp is significantly more complicated than an LLC. So, you will benefit from expert advice to determine if this is your route.
While a CPA team can give you more comprehensive information, especially considering your unique situation, the following are the tax advantages of an S Corp:
1. Pass-through taxes
The owners can absorb the income, losses, and even deductions rather than passing these off as a corporate tax. As a result, you can avoid double taxation, which is more common than you think in C Corporations since the dividends are slapped with taxes at the corporate and shareholder levels.
2. Minimize employment tax liability
The IRS will assume that the income of an S Corp is already distributed even if the owners elect to deposit it in the corporate bank account. For instance, if the business owned by five people has earned $150,000, they can report $30,000 on their income tax returns. However, in reality, they only equally divided the $50,000 after storing away $100,000. So, you avoid paying self-employment tax since owners can also be considered employees.
3. Lower Corporate Tax Bill
Being an S Corp, you can decide to pay yourself in dividends, salary, or both. In the case of the dividend, you don’t have to pay employment tax. You can also deduct the paid wages upon computing the income amount distributed to shareholders. So, overall, you will lower the total tax bill for your company.
However, you need a top-tier bookkeeper to avoid legal entanglements. The IRS watches S Corps closely to ensure a “reasonable” division between dividends and salary.
The S Corporation owners can collectively decide to be taxed as a C Corporation. You only need to file the appropriate forms with the IRS. This part is where the S Corp has the edge over the LLC since the latter’s conversion is more complicated due to the number of filings under the LLC and state laws.
How do you know when to form an S-Corp?
Before making that leap, you need first to consider the following questions:
- Can I absorb the additional costs? You may take in annual and monthly expenses such as state fees, tax preparation fees, payroll taxes, etc.
- Is my corporate taxable income high enough to justify the additional costs? For instance, if your taxable income is only $40,000, an S Corp may not be for you.
- Is your cash flow stable? Remember, you need to cover the monthly payroll.
- What are your future plans? If you invite partners or investors to grow your business, you must amend your charter and change your corporate structure.
The bottom line is you need expert advice from a top-level CPA team. Experienced bookkeepers will assess your organization, operations, and financial status to determine if you are a candidate for an S Corp.
What do you need in place to form an S-Corp?
Before filing the necessary paperwork with the state and the IRS, you must ensure the following:
- Your business is U.S. based
- Your shareholder count must not exceed 100
- You don’t have any non-US citizen/resident as a shareholder
- You can only issue one stock class (common stock)
- File Form 2553 with the IRS
- Eligible since some insurance companies, financial institutions, or exporters are automatically unqualified.
In conclusion, S Corps are ideal for small businesses and startups due to the tax benefits. However, it’s still best to seek the counsel of a high-caliber accountant to ascertain if it’s the right direction for you.
Don’t know where to start?
Start with a call to your top-level bookkeeper at Carefree Bookkeeping. We can save you the time and hassle of figuring out your specific situation and then pairing you up with a qualified CPA.