How To Tell If S Corp Election Is The Right Move For Your Business
An S corporation is not a business entity, rather it is a tax classification created by the IRS. The IRS has defined S corporations as, “corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.” People who are shareholders of S corporations report the income and losses of their share of the business on their personal tax returns and as a result, their tax is evaluated at their personal income tax rate. This feature of S corporations was created to avoid double taxation on corporate income. However, an S corporation is responsible for tax on a few things such as, “passive income at the entity level” and built-in taxes on gains. Double taxation is the process of corporate income being taxed once at the corporate level and then again on the individual level. The pass-through nature of an S corporation avoids this.
Despite the name, an LLC can also qualify as an S corporation. However, an LLC or a C corporation must meet a list of requirements. This list includes the following: Must be a US-based corporation, not being allowed to have more than 100 shareholders or shares of different types, and not be an ineligible entity. If a business entity meets these requirements it must submit Form 2553 which has been signed by all the shareholders of the company.
How to Tell if Your Business Should Become an S Corporation
As was discussed above, an S corporation is not a business entity but rather a tax status which is under Subchapter S of the Tax Code of the IRS. This status can be elected by an LLC or by a corporation. This process avoids double taxation because the corporate income is passed through as personal income. This article will help business owners gain a better understanding of whether electing to become an S corporation will be beneficial to them. These benefits include paying less each month in self-employment tax and having the ability to contribute toward savings and health insurance with pre-tax income.
This may be appealing to many business owners but they will have to meet the following requirements for the decision to make financial sense. The business is required to meet the IRS rules which have been laid out in part above. The owner or owners of the business must earn a “reasonable salary” on a basis that is consistent. The owner or owners should also have the ability to pay themselves a distribution of at least $20,000. And finally, the tax advantage of electing to be an S corporation must outweigh the cost of the S corporation’s maintenance.
The IRS has unwavering deadlines for when a business is able to elect to be an S corporation. A business wanting to become an S corporation the following year can register for this any time in the previous year. The deadline for filing for S corporation status is the 15th of March. A new business can file any time in the year as long as it is within the first two months and 15 days after the company has been incorporated. This is as long as the business wants the S corporation status to take effect.
When a business entity decides to become an S corporation the owners then become employees of the company. As a result of this, because of IRS regulations, the owners must be paid a reasonable salary. A reasonable salary is considered a salary that someone else performing the same role would normally earn. The IRS will check a business to make sure that an S corporation is paying its owner-employees a reasonable salary. There are several potential consequences for not performing this requirement which includes: being denied S corporation status, having to pay a fine, and having to pay back taxes.
To determine whether your business should become an S corporation consider using this S Corp tax calculator which has more information and helpful resources on the subject.
Final Thoughts
There are many things to consider when deciding whether a business should become an S corporation. This has many benefits which include pass-through taxation which can save a business owner a great deal in taxes. However, there are also many requirements and regulations that S corporation owners need to consider. This includes the maintenance of the S corporation status. This can still be worth it for the considerable potential to save on tax.
