S-Corporation (referred to as S-Corp), is a special structure of corporation which exists through IRS tax election. This business entity has a federal tax status in which companies can “pass through” taxable income or losses to the owners, as well as investors of the business. Electing your company as an S-Corp can help you eliminate “double taxation”, which is one of the outstanding features of this business entity.
What Makes an S-Corp?
A company can be treated as an S-Corp by the IRS if it’s operating as a U.S business. If the corporation holds a single class of stock and have shareholders which does not exceed to 100 members. Keep in mind that shareholders for an S-Corp should all be U.S citizens or resident aliens, and that the business should operate in a tax year being set forth by the IRS.
If you’re planning to get your company elected as an S-Corp, then you have to complete form 2553 and submit it to the IRS. Remember that it’s important for your company to specify this federal tax status, or else your company will be considered as a C Corp.
Eliminate Double Taxation
An S-Corp has the privilege of eliminating “double taxation” of corporate income as well as dividends within shareholders. Here is an example of how this process works:
“ ABRI1 Corporation generates a gross annual income of $500,000 a year. Since ABRI1 Corp. is considered an S-Corp, the business will not be taxed, instead the shareholders will be the ones required to pay taxes. As a result, if the company has 4 shareholders, then each of them will pay taxes on $125,000.”
Aside from eliminating double taxation, S-Corporation status has many other advantages that may benefit businesses. S-Corp status keeps the owner’s personal assets protected from any unwanted liabilities like debt, or any other judgment against the company. It only does tax filing once in a year, and as for the business, as long as it’s treated as an S-Corp, have perpetual existence, meaning the business will still exist even if the owner leaves the company or dies.
Payments and Taxes in S-Corp
When it comes to payments in S-Corps, owners should pay themselves through a w2 salary. Owners should also consider “reasonable payments”, especially if the owner is performing employee-type tasks in the corporation. It should reflect the number of hours in his/her work, and remember that the owners can’t overpay or underpay themselves.
One of worst issues of the IRS within these entities are those owners that abuses the advantages of being an S-Corp, such as paying zero wages to shareholders of the company despite earning high amounts per year. This concerns several businesses with shareholders who are actively working as a part of the corporation.
As per S-Corps, the shareholders are the ones who’ll be taxed and not the business. Owners of the company should always remember that they should have two incomes to report in one s-corporation: W2 income for wages and Schedule K-1 for income and losses.