Can An S Corp Save You Money? The Basics of S Corp Taxes

Can An S Corp Save You Money? The Basics of S Corp Taxes

by Brendon Pack, November 2015

Much like snowflakes, corporations come in all shapes and sizes. From farming, to mobile technology, to real estate, corporations represent a part of every industry. If you have the passion and drive to develop your own corporation, you should take ample time and do your homework before choosing the best corporate structure for your venture.

One type of business entity you may want to consider forming is an S corporation.

What Is An S Corporation?

To receive S corporation status from the IRS, a business must meet several requirements. First off, the business must be located domestically in the United States. It can only have allowable shareholders that include individuals or certain types of trusts and estates. S corps cannot be established through partnerships or non-resident alien shareholders. In addition, S corps can have up to 100 shareholders. They can have one class of stock as well. Ineligible companies for S corp status include various financial and insurance organizations.

S Corporation Taxes and Requirements

An S corporation does not pay any federal corporate income taxes. However, this does not mean it is exempt from S corp taxation. Instead of incurring federal income taxes at the corporate level, an S corporation elects to have all of its income, losses, credits, and deductions pass through to its shareholders. The shareholders are then responsible for reporting this financial information on their personal income tax returns to cover their S corporation tax obligations. Shareholders are taxed according to their personal income tax rates, which could vary from one individual to another.

S corps generally are responsible for paying S corp taxes on passive income and any built-in gains within the corporation. When reporting gains and losses, the corporation must file Form 1120S. This S corp tax form is considered an information return rather than a traditional business income return, which C corps are required to file.

S Corp Tax Benefits

An S corp is structured as a pass-through business entity in order to avoid double taxation on the corporate income it generates. With C corporations, taxes are levied at the corporate level and then also levied on individual shareholders. So, you can avoid this double taxation by adopting an S corp structure.

Since an S corp owner is also considered an employee in the company, he or she can reduce payroll taxes by lowering the salary this business owner receives and increasing the distributions he or she receives. You may be able to significantly reduce your self-employment tax liability.

Like most businesses, there are numerous S corp tax deductions that can reduce your business tax bill.

Drawbacks To S Corp Ownership

While an S corporation can be a desirable business entity for many entrepreneurs with its limited liability and tax savings, it does have some drawbacks.

There is certainly more paperwork involved in owning any formal business entity, along with registration fees and potentially high legal and accounting fees to ensure you remain compliant. Some states, such as California, also require S corporations to pay an annual franchise tax to conduct business in the state. On a final note, the IRS has been known to take a closer look at the income earned by S corps. This is why it’s imperative to properly report all income and claim a “fair and reasonable salary” when noting this information on your income tax return.

Is An S Corp Right For You?

There are countless small business structures to choose from, each of which has its pros and cons. An S Corporation works quite well for certain entrepreneurs when it comes to reducing business taxes, limited liability, and more credibility. But it still has its disadvantages in terms of overall fees and restrictions. Be sure to explore all business structures before selecting the most appropriate one for your endeavor.

When you are ready to start a company, LegalZoom can help. Simply answer a few questions about your business online and we’ll use your answers to assemble and file the paperwork to form your company.