S-Corporations, under the right circumstances, can offer significant tax savings to a business entity. An eligible domestic business entity – usually a corporation or limited liability company – elects to be taxed under the S Chapter of the Internal Revenue Code by filing Form 2553 to the IRS.
Choosing to be taxed as an S-Corp also requires experienced legal and financial help. Below are just a few considerations on the pros and cons of deciding to be taxed as an S-Corp.
Like LLCs, the IRS usually taxes S-Corps only once, at the shareholder level. This avoids the so-called “double taxation” of a traditional C-Corp, in which both the corporation itself and the shareholders must pay taxes on profits.
Employee Versus Investor
Payroll tax savings are often an integral component when deciding to be taxed as an S-Corp. This is because S-Corp owners can be treated for tax purposes as both investors and employees. Shareholders of S-Corps, therefore, are only taxed Social Security and Medicare taxes on reasonable wages.
For example, a single-member LLC in which the owner is active in a trade or business must pay self-employment tax, which amounts to roughly 13.3 percent on the first $100,000 in profits. If the LLC chose to be taxed as an S-Corp, however, it only must pay Social Security and Medicare on the wages provided to the S-Corp. If the single shareholder provided services to the S-Corp and his or her reasonable wages were $50,000 on the first 100,000 in profits, the S-Corp could save approximately $7,000 in Social Security and Medicare taxes, despite earning the same amount in profits as it would as a single-member LLC.
Keep in mind the IRS looks very closely at this form of taxation, so an S-Corp must be very careful to pay reasonable wages in order to obtain tax benefits.
Unlike a C-Corp, S-Corp shareholders can often deduct business losses on their personal tax returns. This can be extremely helpful, especially in the first years of a startup, as owners often must invest personally in the business. The losses of a C-Corp, on the other hand, stay at the corporate level.
This article is a brief introduction on some of the tax benefits an S-Corp may provide. Any business owners considering whether to be taxed as an S-Corp should contact a tax or business formations attorney experienced in this matter of law.