S-Corporations come with inherent tax benefits, making them an appealing option for many small businesses. In this article, we explore whether this straightforward election could enhance your tax position.
Companies can find themselves saddled with taxes from all different directions: payroll taxes, excise taxes, and of course, income taxes. While larger organizations may be able to employ sophisticated tax minimization strategies, oftentimes these methods are not practical for smaller businesses. Taxes can dramatically affect the bottom line of a company (or owner), and this gap in tax strategy presents a problem.
Thankfully, there is a tried-and-true option available: the small business corporation, also known as the S corporation. In a nutshell, this structure enables the benefits of the larger, more traditional C corporation (liability protection) with the tax advantages of partnerships or sole proprietorships (a single layer of taxation). As evidenced by the requirements to qualify as an S corporation (see below), this structure is aimed at individually and family-owned businesses, as well as smaller organizations in general.
The most evident tax advantage of the S corporation election is a mitigation of self-employment tax: assuming a shareholder's salary is deemed 'reasonable'—not unreasonably low— then payroll taxes, encompassing Federal Insurance Contributions Act (FICA) and Medicare taxes, are levied solely on the shareholder’s salary amount, rather than the entire portion of their pass-through income. Contrast this with partnerships and sole proprietorships (including single-member LLCs), where the entire amount of taxable income is generally hit with self-employment tax. The self-employment tax rate is roughly 15%, so mitigating the amount of profit subject to this tax can represent a significant savings.
Not surprisingly, there are certain limitations with S corporations: who can elect this status, how distributions are handled amongst shareholders, what qualifies as tax basis, etc. Nonetheless, most of these limitations are not significant factors for the intended users of S corporations.
Reach out today to understand if you can benefit from the S corporation election.
