S Corporation Advantages: Tax Benefits And More
The advantages of an S corporation often outweigh any perceived disadvantages. The S corporation structure can be especially beneficial when it comes time to transfer ownership or discontinue the business. These advantages are typically unavailable to sole proprietorships and general partnerships.
S corporation advantages include:
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How To Elect S Corporation Status
Other businesses that already exist can elect to change their business form to an S Corporation for tax purposes at the start of each year. Certain criteria will have to be met in order to be accepted under this status, and there are some rather strict rules that must be applied to continue to qualify. The qualifications include the following:
- There are no more than 100 shareholders.
- All shareholders must be U.S. citizens no non-resident aliens allowed.
- Only one class of stock is permitted all shareholders must receive the same benefits.
- Other corporations or partnerships cannot be shareholders, but some estates, trusts, and exempt organizations may be permitted.
When Should Your Company Become An S
An LLC owner might want to become an S-corp for the tax advantages while avoiding dealing with the state law formalities of corporations, which would require having officers, directors, board meetings and board minutes.
It could be a good time to consider becoming an S-corp when the company generates enough profit to make the change in tax structure worth it.
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Tax Benefits #: Asset Protection
One other benefit of an S-Corporation to be aware of is that S-Corps provide owners limited liability protection just like an LLC would. If you want to know more about the tax benefits of LLC, then read this post next.
So this means that an owners personal assets such as homes, cash, and cars are protected against lawsuits for example.
Moving Forward With Business Incorporation And The Election
If you have decided to structure your business as an S corporation, and if you are currently operating as a sole proprietor, it is best to seek a professional to assist with the formation of your LLC or corporation. If your business has other partners, shareholders, or members you will need to get them to agree to your decision.
After registering your business, be that an LLC or corporation, make sure to file the S corp election with the IRS within two months and 15 days from the incorporation or formation date. If you have passed that date, you may still qualify for late election approval.
As you look at incorporation and an S corp election, you should weigh the tax benefits and potential administrative costs of the different structures. We see a lot of business owners not knowing their options and the associated benefits, so we want to make sure you are informed.
Wave Advisors can help with your incorporation journey. The Wave team can support your S corporation planning by helping you understand if incorporating makes the most sense for your business from a tax perspective. They can also walk you through processes and forms, like election Form 2553, to help you prepare the strongest possible application, and file easily with the IRS.
Once an S corp election is approved by the IRS, business owners can start using Wave Payroll as an ongoing feature to properly manage their finances and truly reap all of the benefits that come along with being an S corporation.
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Llc Vs S Corp: Which Option Is Best For You
LLCs and S corporations are different aspects of business structure. Choosing to pursue one, both, or neither classification could benefit your business in different ways. Take into consideration your needs when running a business, and ask yourself the following questions to get a better idea of which designation is right for you.
- How many owners have a stake in your business?
- Are all of your business partners U.S. citizens?
- Does a partnership or corporation have a stake in your business?
- How would a self-employment tax affect your net profit?
The answers to these questions can help you determine the fit of an LLC designation or S corpclassification for your business. Below, we’ll explore how the potential answers could affect you and your profits.
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Difference Between S Corp Vs Llc Vs C Corp
The key difference between C-corp and an S-corp lies in tax treatment. In C corporations, corporate income is taxed at the corporate level, whereas in S-corporations it is taxed at the shareholder level.
There are a few key differences between LLCs and S corps when it comes to taxes. S corps can avoid the double taxation that LLCs might face since the taxation of LLCs depends on the number of members in the entity.
As a single-member LLC owner, you have the responsibility to fulfilled taxation as a sole proprietorship , whereas a multiple-member LLC will be subject to partnership tax.
The main difference between these two types of taxation is that a partnership has an additional obligation to file partnership annual information returns to the IRS, while a sole proprietorship file a personal income tax return.
As you can see, the tax benefits of S corp are quite notable. Being qualified for S corp status, however, requires you to meet stringent eligibility requirements.
- Be a domestic corporation
- Have only allowable shareholders, which generally include individuals, certain trusts, and estates
- Have no more than 100 shareholders
- Have only one class of stock
Need a detailed guide to the benefits and drawbacks of an S corporation? Check out our blog article.
Health Insurance Tax Savings
Most S corps shareholders/employees should be able to save additional payroll tax by having their S corp pay for their family health insurance coverage. As long as it is included as part of their wages, and their spouse is not eligible for coverage under a subsidized health insurance plan, this is another great benefit of incorporating.
While the premiums included as wages are taxable personally and subject to income tax withholding , the amount paid is deductible , and the premiums are exempt from employment taxes . This means that the premium is considered self-employed health insurance and therefore is deductible on a shareholder or employeeâs personal income tax return as well. TL DR: this all results in income tax savings.
Letâs go back to our previous example with Emily. To recap: Emily earns $100,000 through her S corporation and pays a reasonable salary of $40,000. If we assume that $10,000 was paid for health insurance premiums, the amount of salary subject to Social Security and Medicare is reduced by the premiums to $30,000. Since we donât need to pay taxes on the health insurance premium, this amounts to payroll tax savings of $1,530 .
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How Are S Corporations Taxed
S Corps are pass-through entities. That means the corporation is not subject to federal income tax like a C Corporation. Much like a partnership or amulti-member LLC , shareholders of an S Corp are taxed based on their allocated share of income.
Shareholders are required to report all financial information relating to the business on their individual tax returns and pay taxes at their regular income rates. This allows shareholders to avoid the double taxation usually associated with a corporation.
Several forms need to be filed with the IRS for S Corps taxes. The first form isForm 2553 which is the Election by a Small Business Corporation form. This form proves that the business meets all the requirements set forth by the IRS to be an S Corp.
For state taxes, every state has its own laws and regulations regarding S Corp taxation. Some states have rules like the federal government in which the corporation is not taxed, while other states require S Corps to pay a state income tax.
How Fringe Benefits For S Corporation Owners Are Taxed
May 25, 2022
In general, the value of statutory fringe benefits paid to employees is exempt from federal income tax. But special rules apply to how fringe benefits for S corporation owners, who own 2% or more of a company, are taxed. For these owner-employees, several fringe benefits are tax-exempt, but others including some of the biggest benefits constitute taxable income. Heres a brief rundown of the tax treatment of fringe benefits for individuals who own 2% or more of an S corporation.
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Benefit # 2 Lesser Self
Say you co-own a small business, filed as an S-corporation. You are the CEO and Co-Founder with 50% shares in the entity. Now assume it made a net profit of $250,000 in 2021. As the CEO, you made $75,000 in salary and received 50% of the net profit, or $125,000.
In this scenario, being an S-corp, you would pay the self-employment tax only on $75,000, while $125,000 would be federal tax-free.
S Corporations Vs Llcs
A limited liability company is a business structure that protects owners from personal responsibility for a corporations debts or legal liabilities. An LLC essentially melds aspects of a corporation with characteristics of a sole proprietorship. S corporations and LLCs are similar in some ways, different in others.
How theyre similar:
- S corporations and LLCs both offer liability shields to owners and shareholdersboth business entities are legally separate from the personal assets of owners and shareholders. Should either an S corporation or LLC be sued, or fall into debt, the personal assets of these groups would be protected from litigants or creditors.
- S corporations and LLCs are also both pass-through entitiesneither form of business pays taxes on corporate income, but both require that owners and shareholders report earnings and losses on personal tax returns.
How theyre different:
- LLCs are a lot easier to establish and less expensive to operate than S corps.
- LLCs are not subject to the same strict IRS rules and are not required to maintain boards of directors or bylaws, or to conduct annual meetings.
- An LLC is also a more flexible entity form, allowing owners to retain more control over operations.
- S corporations have resources at their disposal to incentivize outside fundraisingsuch as issuing stock.
While an LLC can be dissolved if a member or owner withdraws from the organization, an S corporation tends to live on in perpetuity.
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Tl dr: Should You Convert From An Llc To An S Corp
In most cases, if your business has reached a point where youre ready to make it official, you likely earn enough that an S Corp election could help you save thousands of dollars each year in taxes.
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Advantages Of Registering As An S Corp
- The big advantage is the tax benefit: not having to pay federal taxes at the entity level. Saving money on corporate taxes is beneficial, especially when a business is in its early years.
- S corp status can lower the personal income tax tab for the business owners as well. By characterizing money they receive from the business as salary or dividends, S corp owners often lower their liability for self-employment tax. The S corp status generates deductions for business expenses and wages paid to their employees. There are also tax benefits for pass-through entities that apply to S corp owners.
- S corp shareholders can be company employees, earn salaries, and receive corporate dividends that are tax free if the distribution does not exceed their stock basis. If dividends exceed a shareholders stock basis, the excess is taxed as capital gainsbut these are taxed at a lower rate than ordinary income.
- Other advantages include being able to transfer interests or adjust property basis without facing adverse tax consequences or having to comply with complex accounting rules.
- S corporation status may help establish credibility with potential customers, employees, suppliers, and investors by showing the owners formal commitment to the company.
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Should I Have My Llc Taxed As An S Corp
The right structure for your business depends on you, other owners and the business itself, but you should be aware of the benefits and drawbacks of having your LLC taxed as an S corp.
Having your LLC taxed as an S corp includes these upsides:
- The business pays your salary and its payroll taxes. This may save you money on taxes because, as with a regular LLC, you would pay self-employment taxes on the businesss gross income.
- Additional earnings are distributed to shareholders as dividends. This may also save you money, since dividends are taxed at a lower rate than income is.
Having your LLC taxed as an S corp includes these downsides:
- Theres a salary cap. You must establish reasonable compensation for owner-employees.
- There are limitations. Youre limited to one class of stock and 100 shareholders.
- Shareholders own more than 2% of the companys stock and cant claim employee health insurance as a tax-free benefit as they could with a C corp.
Having your LLC taxed as an S corp once you hit the $60,000-a-year mark is a great decision, according to Scott Royal Smith, founder and CEO of Royal Legal Solutions.
This allows you to divide the income between personal income and dividend income and gets you to a lower overall tax rate, Smith said. The drawback is that you also have to pay for an individual S corporation tax return at that point. You have to weigh the tax savings in what youre keeping from the government against how much the CPA is going to charge you.
S Corp And Llc Differences:
- LLCs are simpler to set up and less expensive to maintain. They are not subject to strict IRS guidelines and are not required by law to have a board of directors, bylaws, or meetings.
- S Corporations provide better opportunities for securing outside financing. Unlike an LLC, S Corps have shareholders and can issue stock to investors.
- An LLC can be dissolved if a member or an owner withdraws from the business. An S Corp tends to have perpetual existence.
- LLCs provide more flexibility for owners and allow owners to maintain more control over their business
Choosing which entity to form for your business will depend on your individual business needs. A business run by a single owner who wants to maintain full control of their company and have flexibility should choose an LLC.
If there are several owners involved in a business and the business will be seeking investors for additional funds, then an S Corp formation would be more beneficial.
For more information about LLCs, .
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How Are An Llc And An S Corp Taxed
LLCs and S Corps are taxed as disregarded entities or pass-through entities. This means that the profits of the company pass to the owners or members and are taxed on their personal income tax returns.
C Corporations are taxed as businesses, and the shareholders are taxed on their shares. This is double taxation. Basically, the profits of the company are taxed twice, once as the company’s income, and again as the shareholders’ income.
LLCs and S Corps avoid this double taxation.
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How An Llc Taxed As An S Corp Works
Like a partnership, an S corporation is a pass-through entityincome and losses pass through the corporation to its owners’ personal tax returns. S corporations also report their income and deductions much like partnerships.
An S corporation files an information return reporting the corporation’s income, deductions, profits, losses, and tax credits for the year. S Corp owners must provide shareholders a Schedule K-1 listing their shares of the items on the corporation’s Form 1120S. The shareholders file Schedule E with their personal tax returns showing their share of corporate income or losses.
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What Are Tax Benefits Of An S Corp
S-companies are a common type of legal entity recommended for small businesses. They benefit from the tax advantages of partnerships and at the same time offer limited liability protection for corporations. As a lean business structure, they are easy to set up and easier to maintain than regular C-companies. An S company is a type of small business. A corporation is a separate legal entity from its owners, which means that its owners and shareholders are not held responsible for the company`s finances or shares. In many ways, an S Corp operates like any other business. It operates according to the statutes of the companies of its State of origin and establishes a board of directors and officers, statutes and a management structure. It issues shares of the company. Their owners cannot be held personally or financially liable for claims by creditors or against the company. By forming an S company, you can avoid the double taxation that usually accompanies starting your business. Plus, you can save enough taxes for the self-employed to offset the extra costs associated with starting up and have money left to invest in other parts of your business. If you are a shareholder of S Corporation, you may be held liable. In addition, shareholders of intermediary companies may be taxed wherever the company operates.