S-Corporation: Is It Right or Wrong for My Business?
As a business owner, you may see articles about S-corporation. These are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal taxation purposes. The shareholders of an S corporation will report the flow-through of income and losses on their personal tax returns; taxes are imposed at their individual income tax rates.
The reason for this set-up is to let S corporations avoid double taxation on the corporate income, as they’re responsible for taxes on certain built-in gains and passive income at the entity level.
To qualify for S corporation status, the IRS states that the corporation must meet these requirements:
- Must be a domestic corporation;
- Must have only allowable shareholders;
- May be individuals, specific types of trusts, and estates;
- May not be partnerships, corporations; or non-resident alien shareholders
- Have fewer than 100 shareholders;
- Have only one class of stock; and
- Can’t be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
It’s important to note that the deadline for making a change in corporate status in 2018 is March 15, 2018. If you’re considering making this change, you should understand how S corps work, as well as the advantages and pitfalls.
A C corporation (a traditional corporate structure) that pays shareholders some of its profits as dividends will experience “double taxation.” This means that with regular corporate tax treatment, the corporation pays federal income tax on its income. Any profit distributions to shareholders aren’t tax-deductible expenses for the business, so they don’t reduce the company’s tax liability. When the corporation distributes dividends to its shareholders, the money is reported and taxed a second time when the shareholders file their own tax returns. Again, moving to S corp tax treatment can avoid double taxation.
If you’re the owner of an LLC (limited liability company) who wants to minimize their self-employment tax liability, you want to move to an S-corporation. The IRS views an LLC and its owner(s) as one entity. As a result, an LLC owner (or owners in the case of a multi-member LLC) typically pay income tax on all of the company’s profits (akin to a sole proprietorship or partnership).
Those profits are also subject to self-employment taxes, but with an S-corporation tax treatment, an LLC’s owners pay self-employment taxes only on wages and salaries paid to them individually—not on the remainder of business profits.
The Impact of the New Tax Bill
If you are thinking about making the S corp election, note that the new lower corporate tax rate of 21% might make it more attractive to stay with the normal tax treatment (even with the double taxation) instead of switching to the S corporation’s pass-through tax treatment. An individual shareholder’s tax rates may actually cost more in long-term.
On the other hand, the new tax legislation permits individuals who operate pass-through entities to deduct up to 20% of qualified business income (reduced by capital gains), which may not exceed 20% of an individual’s taxable income. In some situations, that might make S corp election a more cost-effective option.
To see if an S corporation election is for your company, business owners should speak with an experienced business expert.
If you want to move to an S corp election for 2018, you must do so quickly. Existing C corporations and LLCs must file IRS Form 2553 no more than two months and 15 days after the beginning of the tax year. C corporations and LLCs with a tax year that began on January 1st have a March 15, 2018 deadline to apply for S corp election for this year.
If you want to take your time, you can make an S corp election effective in 2019 any time this year.
Contact a Business Expert
Business owners should speak with an experienced business advisor about making a change. Remember that every company’s situation is different.
Andrew is a business expert who’s worked with business owners and those seeking to buy and sell businesses in cities throughout the Sacramento Region, like Rocklin, Citrus Heights, Rancho Cordova, Folsom, Elk Grove, Roseville, Davis, El Dorado Hills, and Cameron Park. Andrew can
help you with deciding on an appropriate opportunity in the Sacramento region, competitive intelligence, financing, in addition to providing answers to all of your questions.
Take the time to speak with Andrew about buying a business. Our website can answer a lot of the questions you might have quickly and for free. If you feel you can’t find the answer you’re looking for feel free to get in touch with Andrew via email or call him at (916) 570-2674.