If you’re still deciding about the exact business structure to choose and you’re juggling between S-corps and other forms like LLCs, you need to be aware of the fact that S Corporations offer a host of possible tax savings which aren’t available to sole partners or proprietors. Since you’re the only shareholder of an S-corp, you will be free to set benefits and compensation in a manner that will boost your tax benefits without adversely affecting the interests of others.
An S corporation is a small business corporation which chooses to be taxed under Subchapter S of the Internal Revenue Code and which offers an electing corporation a portion of, if not all, of the tax advantages of a partnership. An LLC can even opt for this election thereby allowing itself to reap benefits of the payroll tax savings. However, before you take the plunge, here are few things you should definitely know. Read on.
Why were S corporations designed?
Subchapter Small business corporations were designed actually to bridge the gap in between domestic, small corporations and corporate form. This made sure that no member had liability but had 2 different levels of taxation and different forms of partnership and which offered a better tax structure. Here are few benefits of S-corporation.
- Taxes on a single level: Unlike a traditional corporation which requires paying taxes on the income that it makes, for a Subchapter S Corporation, there is no process of double taxation. The profits and losses will be directly passed on to the shareholders.
- Saves on payroll taxes: An S corporation shareholder who is engaged in the business of the corporation actually wears dual hats, that of an employee and that of an owner. The corporation should pay Medicare and Social Security taxes and tax purposes and shareholders aren’t subject to such taxes. In case you’re considering this sort of allocation, it is vital that you ensure that the portion of the salary is reasonable, given the industry and position.
Few pitfalls of Subchapter S Corporation
As you start growing in structure and expand yourself, it may be difficult to stay within the tough and hard regime of Subchapter S Corporation. You should:
- Be a domestic company
- Only employ domestic individuals and few qualifying trusts as shareholders
- Not have above 100 shareholders
- Have only single class of stock
If you don’t satisfy any of the above mentioned requirements, you will win the Subchapter S election and you’ll react to a less favorable tax regime of regular corporation.
Why shouldn’t you opt for an LLC?
An LLC is definitely the most versatile and tax-effective legal entity which a business can choose. An S Corporation offers the usual flow-through tax treatment and hence an LLC is definitely better where debt is involved as it offers more flexibility with no restraints on equity classes and shareholders. The only point is that LLC is more expensive to form and that majority are more familiar with the usual corporate structure.
So, if you want your business to remain small even in the long run where only American shareholders will be involved, an S Corporation might be the best option for you.