The S corporation (S Corp) is a tax status available via the Internal Revenue Service (IRS).
Under the correct conditions, S corporation tax status permits company owners to pay less tax on their revenues.
Continue reading our S Corp Tax guide to discover more about whether to use the S corporation tax status, how S corporation taxes operate, and how to elect S corporation status.
S Corporations Made Simple
There are several aspects to consider while looking for the best business structure for your firm. The most crucial is to comprehend the many sorts of formal and informal business organizations that are accessible. Informal business forms — sole proprietorship or partnership — and legal, formal business structures — limited liability company (LLC) or corporation — are among the possibilities available to you.
An S corporation (S corp) is an alternative tax classification to a C company. An S corporation is taxed differently, has distinct criteria, and may be chosen by either an LLC or a corporation. We’ll go over all you need to know about S corp taxes so you can make the best decision for your company.
Important Takeaways:
An S corporation, also known as a subchapter S corporation under the IRS law, is a tax classification rather than a legal corporate organization.
There are various IRS requirements that a S corporation must meet.
In most states, S corporations do not pay corporate taxes.
Pass-through taxes provides for the direct transfer of company revenue, losses, deductions, and credits to shareholders.
Individual tax returns are filed by owners or shareholders who report income and losses at their own tax rate.
S companies may have up to 100 stockholders, all of whom must be US citizens or permanent resident aliens.
An S company must have its headquarters in the United States.
What Exactly Is a S Corporation?
An S corporation is a tax status under the Internal Revenue Code (IRS) Subchapter S that LLC or corporation owners elect by submitting Form 2553. By electing S corp classification, a company may enjoy pass-through taxes, much like a sole proprietorship, partnership, or LLC. An S company also provides certain advantages to companies without the double taxes. A subchapter S permits corporate losses, deductions, and credits to be passed down to shareholders for tax purposes. As a result, stockholders may deduct taxes on their own tax returns.
Why Would You Go with a S Corp?
Under the correct conditions, S corporation tax status permits company owners to pay less tax on their revenues.
If the following four conditions are met, you should decide to be taxed as a S corporation:
You know you’ll want to take a significant amount of money out of your firm rather than reinvest profits to develop it year after year.
You are certain that your company will create enough profit to provide the owner(s) a respectable salary as well as at least $20,000 in yearly dividends.
Your company is an LLC or a corporation.
The company satisfies the S corp standards.
Taking Money Out of Your S Corporation
Some company owners will want to take a substantial amount of the earnings out of the firm to pay themselves (depending on the sort of business and stage of development).
Businesses that are S corp prospects have minimal expenses and reasonably large profits.
Small firms with little overhead and a high profit margin may be suitable candidates for S corp tax status.
S corporations are often appropriate for the following two categories of businesses:
Service firms with little overhead and relatively large profit margins, such as electricians
Small enterprises in expansion that intend to maintain strong profit margins vs expenditures
A reasonable salary and distributions of at least $20,000
Before deciding on S corporation tax status, you must be certain that your company will make enough profit to pay the owner(s) a respectable compensation and at least $20,000 in yearly dividends.
A decent pay is one that is in line with the market for the job done.
When a business owner chooses S corp tax status, they are taxed as employees of the company. This implies that the proprietor of the firm will no longer have to pay self-employment taxes on distributions.
Exemplification is the best method to comprehend S corp tax savings.
Example 1: Electrician Business.
In this example, an electrician forms an LLC and must pay 15.3% self-employment taxes (FICA, Medicare, and Social Security tax) on distributions, in addition to regular income taxes.
If the electrician generates $100,000 in net profit (profit after expenditures) and distributes the whole amount to herself, she will be required to pay $15,300 in FICA self-employment taxes on top of her regular income taxes.
The electrician is classified as an employee of the company under a S corp and is no longer liable to self-employment taxes.
S Corporation Taxation on Reasonable Salary
The electrician must pay herself a fair compensation as a company employee, which is liable to employee FICA taxes and income taxes.
If the electrician earns a realistic income of 70,000, they will pay $5355 in FICA taxes on the wage, and the company will pay $5355 in FICA taxes on their behalf. The total FICA for the S corp is $10,710 against $15,300 without the S corp classification.
This is a $4590.00 save.
S Corporation Distribution Tax
Distributions from a S corporation are no longer subject to self-employment FICA taxes. Distributions, on the other hand, are passed through to the employee-individual owner’s tax return and are solely liable to income tax.
The electrician with a net profit of $100,000 will get a dividend of $26,645 (the remaining net profit after FICA taxes of $5355).
Accounting and Payroll Costs
Owners of S corporations will need to engage payroll and accounting expertise. This expense must be mitigated by tax breaks. To justify the increased expenditure, we estimate that payout amounts must be at least $20,000 per year.
Payroll and accounting expenses for the electrician must be less than $4590.
S Corp Phase 2: Small Business Growth
A Bakery firm has begun its expansion phase after much hard work. In this case, the proprietor has most likely spent many years reinvesting profits back into the Bakery. They may have even missed paying themselves in order to expand the firm.
The company’s profit currently greatly surpasses its expenditures. There is enough profit to pay a respectable wage and provide considerable payments to the Bakery owner.
S Corp Status is available to LLCs and Corporations.
To be taxed as a S corporation, your company must be organized as an LLC or corporation.
If your company is already an LLC or corporation, you may opt S corp status by filling out IRS form 2553. To learn more, see our How to Elect S Corp Status guide.
If you haven’t yet created an LLC or corporation, you may choose S corp while applying for your Employer Identification Number (EIN). Step-by-step instructions may be found in our Start a S Corp guide.
S Corporation Prerequisites
The IRS requires firms that choose S corp status to:
Have no more than 100 stockholders.
Issue just one kind of stock.
Have US citizens or permanent resident aliens as proprietors.
Private people own them rather than commercial entities such as LLCs, companies, or trusts.
S Corporation Tax Rate
Because, like an LLC or sole proprietorship, S corp revenue transfers through to the owner’s individual tax return, the S corp does not have a set tax rate. At that moment, the revenue is subject to the following:
Federal income taxation
Income taxation in the state
Employer and employee FICA taxes
Federal and State Income Tax Rates for S Corporations
In a S corporation, the company owner(s) are treated as workers for tax reasons.
S corporation revenue, including reasonable compensation and distributions (draws), is reported on the employee’s personal tax return.
Employees’ reasonable earnings are liable to federal and state income taxes, as well as FICA taxes. Only federal and state income taxes apply to distributions.
The federal and state income tax rates are determined by your taxable income, your tax bracket, and your filing status.
Employer and employee FICA taxes
Because the company owner(s) in a S corporation are workers, they are not obliged to pay self-employment tax (full FICA tax), and distributions are only subject to state and federal income tax.
15.3% self-employment tax rate
Self-employment tax is essentially full FICA taxes (Medicare and Social Security) that must be paid for every dollar earned by any individual. FICA costs are divided 50/50 in an employee/employer relationship. The rate of self-employment taxation is 15.3%.
By forming a S corporation and being regarded as an employee, the company owner pays FICA on ONLY their fair compensation. Only federal and state income taxes apply to distributions.
Example:
In the above example, the electrician makes a $100,000 net profit and would owe 15.3% in FICA self-employment taxes if they did not adopt S corp tax status. That’s $15,300!
She earns $70,000 each year as a S corporation. As part of her individual tax return, she will pay 7.65% FICA taxes, or $5355. The remaining $5355 in FICA taxes is paid by the firm, for a total of $10,710 in FICA taxes paid by the employee and the employer.
The company owner gets a total payout of $24,645 as a S corporation and a fair compensation of $70,000 for a total of $94,645 (compared to $84700 as a default LLC or sole proprietor).
S Corporation Tax Calculator
We recommend utilizing our S corp calculator while choosing whether to elect S corp status.
To begin, calculate your net earnings for the tax year. We suggest starting with a little amount that you anticipate to remain constant year after year.
Following that, you must calculate a fair wage for the labor you accomplish for your company. You can compare similar salaries on websites like Glassdoor or the US Bureau of Labor Statistics to determine a reasonable salary for your position.
You must balance your tax savings with the cost of payroll and accounting services. To learn more about pricing, read our Best Payroll Service review and schedule a free accounting consultation.