When it comes to your small business, there are countless financial decisions to make. One of the most important is selecting a business structure.
This decision impacts how you pay taxes and how much legal paperwork you need to file each year. With the upcoming S Corporation deadline on March 17th, here are important things to keep in mind.
S Corporation Election Gives You Pass-Through Tax Treatment
A regular C Corporation is taxed as its own entity. Each year, a corporation files Form 1120 with the IRS to report its income and deductions.
The business’s profits are taxed using the corporate tax rate table. When you elect S Corporation tax treatment, these profits are passed along to the business owners or shareholders. For example, if you own 40 percent of an S Corporation, you are responsible for reporting 40 percent of the business’s profits on your personal tax return.
S Corporation Election Can Be a Way to Avoid Double Taxation
With a C Corporation, business owners can feel as if their profits are taxed twice.
First, the corporation is taxed on its profits. Then, if those profits are distributed to shareholders as a dividend, the individuals pay taxes on the dividends. If an entrepreneur is looking to take money out of the corporation (rather than re-investing it), they can end up paying more in taxes with a regular C Corporation.
An S Corporation Lets you Pass Through Losses as Well
When you elect S Corporation tax treatment, shareholders are allowed to pass the losses to their personal tax return.
If you anticipate a loss with your business, then an S Corporation may let you report the loss and offset any other personal income for the year.
An S Corporation May Not Be Smart If You Want to Keep Profits in the Business
Keep in mind that with an S Corporation, all profits are automatically passed along to the shareholders, at least when it comes to reporting income to the IRS.
If your S Corporation business makes $100,000 in profit for the year, you will be required to report your percentage of the income, even if you keep the money in the business and never see a dime personally.
An S Corporation Isn’t Actually a Business Structure
An S Corporation is a tax election made with the IRS. It means that your company will be taxed differently, but everything else remains the same.
If you have a C Corporation and file for S Corporation election, your business is still treated like a C Corporation in all other respects. Likewise, an LLC can also choose to be taxed like an S Corporation.
Not Every Business Can Qualify
The IRS places strict restrictions on which businesses can elect to be S Corporations.
There can be no more than 100 shareholders. All shareholders need to be U.S. residents and individuals. They can’t be partnerships or corporations.
In addition, you can only have one class of stock with an S Corporation.
An S Corporation Doesn’t Give You Flexibility on Allocating Profits
With S Corporation election, profits and losses must be passed through to the shareholders strictly based on their percentage of stock ownership.
As mentioned above, if you own 40 percent of the stock, you need to report 40 percent of the profits or loss.
Owners can’t make any special agreements or arrangements for allocating profits and losses for the year.
Can Be a Way to Minimize Self-Employment Taxes
Some self-employed individuals opt to form a corporation or LLC and then elect S Corporation status.
This gives them the option to divide up their business earnings into both salary and distributions. Their salary is subject to social security and Medicare, but the distributions are not.
Keep in mind that if you adopt this strategy, you need to pay yourself a reasonable salary for the work you do and it’s smart to talk things over with a tax advisor.
A Business Structure is Mainly About Minimizing Liability
While small business owners are usually focused on lowering their taxes, the most important reason to form a legal business structure is for liability protection.
With sole proprietorship or general partnerships, there is no separation between the business owner and the business. If your business is sued, your personal assets may be on the hook.
However, once you form an LLC or corporation, this act puts a shield between your personal assets and the business.
The S Corporation Deadline is March 16 For Existing Businesses
If you want to elect S Corporation tax treatment for 2015, you need to act quickly. Existing businesses have two months and 15 days from the start of their tax year (that’s March 16, 2015 for calendar year reporters). Brand new businesses have two months and 15 days after the company is formed to file the election.
Otherwise, they need to wait until the next tax year for S Corporation election to take affect.
To elect S Corporation status, you need to file IRS Form 2553.
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