Creating a business brings forth lots of questions, such as finding the best market, picking the fitting business model, and defining workforce requirements, among many others. Foremost of all, though, is deciding your business structure because it will affect your firm's facets.
Just like all corporations, the S Corporation, also known as S-Subchapters or S-Corps, is a separate entity from its owners. Thus, it files a separate tax return while individual owners file their tax returns. K-1 is the tax form shareholders receive, which is the counterpart of the W-2 form of employees. Pass-through taxation denotes that its income is not subject to Corporate Tax. Instead, its operation result, be it an income or loss, is allocated among the shareholders directly consistent with their respective ownership percentage in the business.This share in the operation result is then reported on each shareholder's income tax return on Schedule E.
The S-Corps business structure meeting IRS requirements are as follows: 1. All owners are permanent residents or citizens of the USA; 2. It submits a 2553 Election by a Small Business Corporation form that each owner duly signs; 3. It has only one class of stock; 4. The total number of owners do not exceed 100 persons, counting certain trusts and estates; and, 5. The company is within the USA Take not that corporations, partnerships, and non-resident aliens cannot be owners of an S-Corps. The business should also not be among those insurance firms, financial institutions, and domestic transnational sales corporations explicitly disqualified in the IRS Code. One of the requirements of S Corporation is that it needs to issue payroll.
Forming your firm as an S-Corps offers these aids: 1. Protected Assets Since S-Corp is a separate entity, a shareholder does not have personal liability for the business debt of the corporation meaning their personal assets are protected. However, in a sole proprietorship or general partnership, the personal assets of the business owner(s) are vulnerable. 2. Ease of Ownership Transfer By and large, ownership transfer is more stress-free as compared to businesses of other structures. Shareholders can buy/sell ownership without risking termination of the entity and accounting headache. 3. Independent Life The life of the S-Corps is not contingent on its owners. Since shareholders can change anytime without affecting the business, it is easier for management to create a long-term growth plan. 4. Self-Employment Tax In addition to avoiding double taxation, the S Corporation structure can also decrease self-employment tax because normally, shareholder’s income will be divided into two parts: distribution and salary. Self-employment tax applies solely to salary; thus, reducing the tax liability.
1. What is the immediate tax savings of an S Corporation? S Corporations save a lot on payroll taxes. The pass-through income reported on K-1 is NOT subject to FICA Taxes (Social Security and Medicare) of 15.3%. However, the W-2 is subject to self-employment taxes. For example, suppose the S Corporation has $100,000 in profit and issues $30,000 of payroll to the shareholder. In that case, the corporation has $70,000 in profit on the tax return. The $70,000 is NOT subject to payroll taxes, resulting in a tax savings of $10,710 in FICA taxes. 2. What happens to owners who happen to be the only corporation worker? In such cases, the owner is considered an owner/employee entitled to receive a salary and a profit distribution. 3. How do you determine the W-2 amount for the owner/employee? The owner/employee must be reasonably compensated for the work rendered to the business. Reasonable compensation is not a black and white rule. It depends on factors, like the number of hours the owners put into the business and skill level. It would be best to base the owner/employee's salary on how much it would cost to hire someone to do the job at today's current rate. Choosing an S Corporation structure for a business is a smart move, although it does not fit all employers. If unsure about your company's best business structure, it is highly recommended to consult an accountant. After all, there are always exceptions to the rules. Thus, the guidance you will receive from these experts can help you start your business right. If you have any questions in regards to S Corporation, contact Kauffman|Kim, LLP today!