S Corporation - My Favorite Tax Structure

What is an S-Corporation?

An S-corporation is a corporation that makes a federal election to have the federal income taxes paid by its shareholders rather than to the Company. In most cases, S corporations do not pay any federal income taxes. Instead, all items of business income, losses, deductions and credits are passed through to the S corporation’s shareholders and are reported on the shareholder’s tax returns. The S Corporation reports these amounts on Schedule K-1 which is distributed to each shareholder to report his or her proportionate share of the earnings.

When Is the S Corporation Tax Return Due?

In general, the S corporation federal tax return is due on, or before, March 15th (or 2 ½ months after year-end). S corporation federal tax returns can usually be extended until September 15th (or 9 ½ months after year-end). If you miss this deadline, you may be subject to a late filing penalty.

S Corporations and Income Taxes

The beauty of the S corporation structure is the avoidance of double-taxation normally associated with the C corporation structure. In the C corporation structure income taxes are assessed at the federal level to the corporation, then assessed a second time to the individual shareholders upon the withdrawal of the net earnings in dividends. For example, let’s say your corporation makes $100,000 after expenses. Using an approximate tax rate of 30%, you would pay $30,000 in income taxes at the corporate level leaving $70,000. If you then took the $70,000 out of the Company, you would be taxed an additional $21,000 resulting in total income taxes paid of $51,000 or 51% of your earnings. In contrast, under the S corporation structure, you would pay a single level of tax on the earnings, or $30,000 only on the individual level. Keep in mind that this example is very simplistic as tax rates are only approximated and ignores other strategies that we can implement to help you.

S Corporation Distributions and Taxes

Perhaps the most common misconception associated with S corporations is how distributions are taxed. The fact is that generally they’re not. You are taxed on corporate earnings and not how much money you withdraw from the Company. Whether you withdraw only $1, or $1 million, has no effect on your taxes. You are taxed on your proportionate share of the earnings of the Company.

First Year S Corporation Tax Returns

Yes, you have to file a first year tax return, even if you didn’t do any business.

Payroll and S Corporations

One of the unfortunate downfalls of many S corporations is that the owners fail to take a payroll, incorrectly believing that if they didn’t make much, or if they had payroll from other sources, a payroll return isn’t required. If you didn’t take a payroll, you could potentially be subject to payroll taxes on what you should have paid in upon examination. Unfortunately, if you didn’t take a payroll … well there’s not much you can do about it now, except probably to correct it in the following year.

State Income Taxes and S Corporations

Certain states treat S corporations differently subjecting them to minimum or franchise taxes, or disregard the tax benefits associated with S corporations.

Termination of an S Corporation

The termination of an S corporation concerns the ending of the preferred S corporation status. It is not necessary ending the business, but rather the changing of the S corporation status to something different. Of most concern is the inadvertent termination of the S corporation, in which the Company has an event that terminates the S corporation status. For example if an S corporation enters into an agreement to admit a foreign shareholder, the preferred S corporation status is lost and the corporation will thereafter be subject to taxation as a C corporation. Such results can be quite different, even disastrous, for everyone else.

Summary

These are just some of the more common considerations you need to know involving taxes and S corporations. There are always lots of mistakes by owners in meeting or maintaining the stricter requirements of this entity type. In many cases, if you have a problem, we can help. If you don’t think you have a problem, but are perhaps interested in lowering your taxes, we can review this with you as well.