What is the biggest tax benefit of choosing an S corporation?
Perhaps the most significant benefit of an S corporation over a C corporation is the avoidance of double taxation. The net income of a C corporation is taxed at the corporate level. To get those profits to the shareholders, the C corporation pays dividends to the shareholders, which are then taxed at the shareholder level. In an S corporation, by contrast, all of the corporation’s net income passes straight through to the shareholders, who pay taxes on it via their personal returns. This avoids the double taxation that occurs with a C corporation.
How does filing taxes work with an S corporation?
S corporations are required to file a Form 1120-S federal tax return each year. The due date is generally March 15 of the following year for S corporations operating on a calendar year. For example, a calendar year S corporation’s 2023 federal income tax return is due on March 15, 2024. In addition to the federal return, most states require S corporations to file a state corporate tax return.
Generally, no income tax is due on the S corporation’s federal income tax return because S corporations are pass-through entities for tax purposes. The S corporation’s return is a Schedule K-1 for each shareholder of the S corporation. The Schedule K-1 reports the shareholder’s portion of the business income or loss. The Schedule K-1 also reports other important items, such as distributions that the shareholder received from the S corporation. The shareholder is then expected to report the Schedule K-1 on their personal tax return and pay tax on the business income on their personal return.
Am I required to send a W-2 to shareholders who work for my S corporation?
S corporations are generally required to pay reasonable compensation to shareholders who work for the business. The reasonable compensation is typically paid as payroll, in which case it’s best practice for the business to issue a Form W-2 to the shareholder. The amount of W-2 compensation that is necessary to meet the reasonable compensation requirement varies from business to business and depends on many factors, such as the amount of work done by the shareholder, the amount of profit of the business, and the amount of income that is attributable to capital and equipment owned by the S corporation. If you are unsure how much W-2 compensation is needed in your specific situation, consult with a tax professional for guidance.
How is my self-employment tax liability affected if I form an S corporation?
One of the unique tax features of S corporations is that they can reduce your self-employment tax liability in some circumstances. If you operate your business as a sole proprietorship, then all of the net profit of your business is typically subject to self-employment taxes. However, with an S corporation, the net profit of the business is not subject to self-employment taxes. Any payroll wages that are paid to you from the S corporation are subject to employment taxes, but the remaining net profit that passes from the S corporation to your personal return avoids employment taxes. Selecting an appropriate amount of W-2 compensation is important when you work for an S corporation that you own, and it is recommended that you work with a tax professional to ensure that all IRS requirements are satisfied and to ensure that you are optimizing your taxes.
What potential administrative expenses might I face as the owner of an S corporation?
While operating as an S corporation may bring potentially significant tax benefits, it comes with some additional administrative burdens that do not apply to all tax structures. A sole proprietor reports their business activities as part of their personal income tax return, whereas an S corporation files a business return that is separate from the shareholder’s personal return. Additionally, because of the reasonable compensation requirement, your S corporation may be required to run payroll – something a sole proprietorship may be able to avoid. Sole proprietorships may be easier to operate, but they are often not the most efficient tax structures, and offer no liability protection. Although the administrative expenses of operating an S corporation are generally more akin to operating a partnership or C corporation, they can be worth it.
Whether you are considering an LLC, partnership, S corporation, or C corporation, Rocket Lawyer business formation specialists are here to help. If you have more questions about the tax benefits for each type of business structure, or what might be best for your business, reach out to a Rocket Lawyer network attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.