S corporation taxes are complicated.
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What is an s corporation?
An s corporation is actually an elected type of taxation for an already created LLC or corporation.
It’s not so much a type of entity, but a way that the IRS sees that entity for tax rules.
Entity formation is generally formed at the state level, then taxation for that entity is often defaulted or elected at the federal level.
How do I form one?
You start with an LLC (single or multi-member) or a corporation. If all of the members/shareholders qualify, you can elect for the entity to be taxed as an s corporation using form 2553.
Unless you ask for relief for being late, you must elect to be treated as an s corporation no later than 75 days into the s corporation’s tax year. This is usually from the date that the entity is formed (in the first year) and it is often the 15th of March (in subsequent years) for s corporations that follow a calendar year.
Once you elect to be taxed as an s corporation, as long as the shareholders continue to qualify, and entity generally maintains its s corporation status each year. You do not need to make the election each year.
Should my small business be taxed as an s corporation?
While the election can often save you a lot of tax, this is not a simple question to answer.
The answer generally depends on whether or not your business makes a decent net profit (net income after expenses). If a business does not make much in profit, then any advantages would be offset by the higher tax compliance costs.
Also, it only makes sense to elect s corporation taxation if you are a business owner who can make tax compliance a priority. If you are often delinquent on your taxes, a lack of tax compliance might leave you in a bad position.
Will an s corporation help me to reduce my taxes?
It depends, but for some small business owners, electing s corporation could save them a significant amount of taxes each year. Tax liabilities can sometimes be reduced by thousands or even tens of thousands of dollars.
The most significant savings might come from a reduction in self employment tax, but an s corporation can save business owners taxes in other ways too, such as in a multi-year audit disallowance.
Is it expensive to be an s corporation?
A little bit, yes. This is why it often only makes sense to become an s corporation when your business makes enough net profit – when the tax savings exceed the costs.
There is a requirement to file a complicated business income tax return each year, federal and state(s). In most cases, you will also be required to run payroll for owners who provide more than minimal services and labor to their s corporation. Running payroll includes filing payroll tax returns, such as form W2 and 941. The salary paid to owners must be a “reasonable” amount.
You can go online and do some of this yourself to save a little bit of money, but staying up to date on your taxes are complicated and time consuming. It’s best for most small business owners to hire a tax professional for these items.
How do I figure out a reasonable salary.
Finding a reasonable amount to pay yourself and other shareholders can be tricky.
There are expensive analysis services that can help you decide,, or you can do your own research. But generally, the salary amount must be a similar amount to what it would cost to replace the labor with a non-owner employee.
But it’s not quite that simple. There are other factors to consider such as the amount of the shareholder distributions.
There are common errors and traps for s corporation beginners.
If you are thinking of becoming an s corporation, I strongly advise that you first talk with a professional about it. Too often do I see taxpayers do some internet research, jump out on their own and elect to be taxed as an s corp, and then find themselves non-compliant.
It’s not exactly rocket science, but unless you are willing to take a 3 month course, it’s best to have help from a tax professional with s corporation experience.
Reimbursements under an accountable plan.
When operating as an s corporation, the business can generally reimburse expenses that employees encounter for the convenience of the employer.
If this is done correctly under an accountable plan, and the expenses are ordinary and reasonable, the expense reimbursements can become a deduction to the business but will not be considered income to the employee.