Small Biz Guide: Everything You Need to Know About S-Corporations

If the viral videos on TikTok and YouTube are to be believed, every business owner should immediately form an S-Corporation for their business. From tax savings to protecting your personal assets, from increased credibility to a fixed and stable salary, there are many benefits to running an S-Corp. 

 

However, that’s not the entire story.

 

As the owner of an S-Corp, there are additional liabilities, obligations, and requirements that you need to fulfill. In this guide, you will find answers to all your questions about S-Corporations and everything else you need to know.

 

What is an S-Corporation?

If you are wondering how S-Corporations work, you are not alone. They are more complex business entities than a simple sole proprietorship or LLC.

“S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.” – Internal Revenue Service

In an S Corp, income and losses of the S Corp “flow through” the company to its shareholders. The shareholders then report these profits and losses on their personal tax returns. As such, an S Corp is considered a pass-through entity and owners can avoid having to pay taxes twice on the corporate income.

 

What are the Requirements for S-Corps?

Companies need to fulfill certain requirements to file for S-Corporation status.

  • The company must be a domestic corporation (i.e. LLC)
  • It has a maximum of 100 shareholders.
  • The shareholders must be individuals, certain trusts, and/or estates. Partnerships, other corporations, and non-residents cannot be shareholders.
  • S Corps can also only have one class of stock.

 

Certain corporations are also ineligible to file for S-Corp including financial institutions, insurance companies, and domestic international sales corporations.

 

Pros vs. Cons of Being an S-Corporation

As with any decision, there are advantages and disadvantages to filing for S-Corp status. As a business owner, you need to consider these before making your decision.

 

Advantages of Being an S-Corp

    • Limited Liability Protection: Your personal assets will be protected if your company has outstanding debts or liabilities.
    • Zero Tax at Entity Level: Profits and losses flow through the company and are recorded and paid at an individual level, avoiding double taxation.
    • Bypass Self-Employment Tax: As the owner of an S-Corp, you get paid a salary and do not have to pay self-employment tax, which results in tax savings.
    • Tax Savings: The company can deduct your salary as an expense and does not have to pay tax on it. As the owner, any income through distribution payments is tax-exempt.
    • Greater Credibility: S-Corporations are viewed as more legitimate and reliable. Getting personal loans from banks is also easier.

Disadvantages of Being an S-Corp

    • Compliance Costs: There are additional compliance costs associated with becoming an S Corporation
    • Additional Accounting Fees: Accounting fees are higher as you have to file two tax returns (personal and S-Corp).
    • Paying Owner’s Salary: When electing S Corp, you will now have to pay yourself a reasonable salary by way of paying yourself on a W-2.
    • Payroll Costs: Additional time, effort, and monetary costs are incurred from managing payroll (e.g. use of payroll software like Gusto).
    • Increased Paperwork: There is often more paperwork associated with running an S-Corporation than a sole proprietorship and you may need additional assistance from an accountant and/or admin assistant to manage it.
    • Initial Accounting Fees to Get Started: There is often a cost associated with registering your company as an S-Corp.
    • More Structured: An S-Corporation has certain obligations to fulfill and so needs to have certain structures in place to ensure compliance.
    • Mindset Shift: If you are used to operating as a sole proprietor (e.g. freelancer or independent contractor), running an S-Corp will require a mindset shift to run it more like a business.

Obligations of S-Corporations

There are many obligations S-Corporations have to fulfill, but the most important ones are payroll (particularly paying the owner a salary) and taxes (mainly filing taxes as an S-corporation and employment taxes).

 

How to Get Paid as an S-Corp Owner

As the owner of an S-Corporation, there are two channels for you to get paid – your salary as the owner and shareholder distributions.

The IRS has strict regulations about wage compensation for S-Corporation officers i.e. the salary that you draw as the owner. While the exact formula the IRS uses to calculate what it considers to be a “reasonable” salary for the owner has not been disclosed, there are certain elements that go into determining this salary range. 

Some of them include:

  • Training and experience
  • Duties and responsibilities
  • Time and effort devoted to the business
  • What comparable businesses pay for similar services
  • Compensation agreements

 

Failing to adhere to these regulations will result in additional action being taken against your company by the IRS.

Apart from your salary, you can also enjoy the profits of your S-Corporation as distributions. These are usually paid out by the company from profits at the end of the year and are exempt from Social Security and Medicare taxes. However, there is no guarantee that you will receive these distributions, as it is dependent on the financial performance of your company in that year or period.

 

Taxes as an S-Corporation

The IRS outlines the tax obligations of an S-Corp as income tax, employment taxes, and excise tax. S-corporations are responsible for tax on certain built-in gains and passive income at the entity level and these taxes should be filed with Forms 1120-S or 1120-S (Sch. K-1).

In terms of employment tax, S-Corporations must be responsible for Social Security and Medicare taxes, as well as income tax withholding for employees. It is also liable for Federal Unemployment (FUTA) tax and for depositing employment taxes. Excise tax is also another obligation to the IRS that S-Corporations need to consider.

 

Becoming an S-Corp: A Logical Choice?

There is no easy answer for any company considering whether or not to become an S-Corp. A multitude of factors come into play and your own personal circumstances as the owner can also influence the final decision of whether to convert your company into an S-Corp. In some cases, it may be financially prudent to remain as a sole proprietor or LLC instead of electing an S-Corp.


That’s why at Exceptional Tax Services, we are committed to providing our clients with the best possible advice and service for your personal situation and unique business when it comes to electing an S-Corp. We take into consideration your specific financial situation to advise you on the best course of action.

 

If you think your business is ready to become an S-Corp, speaking with a financial professional should be your next step. Don’t hesitate to reach out to Exceptional Tax Services! We will run your numbers and create detailed projections for what becoming an S-Corporation would mean for your business so that you can make the decision confidently. We’ll even guide you through filing the paperwork too. Book a call to get started or learn more about S Corps in the All About S Corporations Mini Course.

In addition you can read more about it here: S Corporation Elections with ETS

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Nacondra Moran

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