Updated: Jun 27
When it comes to structuring a business, entrepreneurs have several options, one of which is the S-Corporation (S-Corp) status. An S-Corp is a unique tax designation that provides certain advantages to small and medium-sized businesses. In this blog post, we will explore the benefits of electing to be treated as an S-Corporation, helping you understand why this choice can be advantageous for your business.
One of the most significant benefits of S-Corp status is the pass-through taxation. Unlike a traditional C-Corporation, where the company is taxed separately, an S-Corp allows the profits and losses to pass through to the shareholders. This means that the business itself does not pay federal income taxes. Instead, the shareholders report their share of the company's income on their personal tax returns, which can potentially lower the overall tax liability.
No self-employment tax:
The primary difference between an LLC (sole proprietor or partnership) and an S-corp is that shareholders in an S-corp will not have to pay self-employment tax on the net profit from the business. In an LLC, the net profit will flow through to the owners, and self-employment tax will be charged on the full net profit. That can sometimes result is a significant amount of tax. One downside to choosing an S-corp is that shareholders are required to receive a "reasonable salary" and withhold payroll taxes on that salary just like a regular employee would on a W-2. What is a "reasonable salary"? That is not clearly stated by the IRS, but we do know that the shareholder salary can be much less than the full profit created by the business. This could be a huge saver on the self-employment tax.
Avoiding Double Taxation:
As mentioned earlier, S-Corps do not face double taxation, which is a common concern for C-Corporations. In a C-Corporation, the company is taxed on its profits, and then shareholders are taxed on dividends received from those profits. This double taxation can significantly reduce the after-tax earnings available to shareholders. By electing S-Corp status, you can bypass this issue and potentially save on taxes.
Limited Liability Protection:
S-Corporations offer limited liability protection, similar to C-Corporations. This means that the shareholders' personal assets are generally protected from business liabilities, such as debts or legal obligations. While there are exceptions to this rule, maintaining the S-Corp status helps separate personal and business assets, reducing the risk of personal financial loss due to business-related issues.
Credibility and Perpetual Existence:
Forming an S-Corporation often provides your business with added credibility in the eyes of customers, suppliers, and investors. The "Inc." or "Corp." in your company name suggests a certain level of professionalism and commitment. Additionally, an S-Corp can have perpetual existence, meaning that it continues to exist even if the owner(s) leave or sell their shares. This stability can provide confidence to stakeholders and potential partners.
Eligibility for Deductions and Fringe Benefits:
S-Corporation owners can take advantage of various deductions and fringe benefits not available to other business structures. For instance, as an S-Corp owner-employee, you may be able to reduce your self-employment tax liability by designating a portion of your income as a distribution rather than salary. Moreover, S-Corps can offer various tax-deductible benefits like health insurance premiums, retirement plans, and more, providing additional tax savings for both the business and its owners.
Ease of Transferability:
Transferring ownership in an S-Corporation is relatively straightforward. Shareholders can sell their shares or transfer ownership to others without major complications. This flexibility can be beneficial for businesses with succession planning or if you are considering raising capital by bringing in new investors.
Choosing to be treated as an S-Corporation can be a strategic move for your business, offering numerous benefits such as pass-through taxation, avoiding double taxation, limited liability protection, enhanced credibility, eligibility for deductions and fringe benefits, ease of transferability, and more. However, it's crucial to consult with a qualified tax professional or attorney to understand the specific implications and requirements based on your unique circumstances. By leveraging the advantages of an S-Corp, you can optimize your tax situation, protect your assets, and position your business for long-term success.
Making the election is relatively easy. The entity will at least need to complete and file Form 2553 with the IRS by March 15 of the tax year in which the entity is electing to be treated as an S-corp. The IRS does provide relief for a late election assuming the electing entity has reasonable cause for making a late election.