- 1 S-CORPORATION TAX STRATEGIES
S-CORPORATION TAX STRATEGIES
The S-Corporation Offers Some Tax Strategy Benefits
Tax Tips For The Small Business Owner
This information is meant to be a brief overview only, and it is recommended that the reader do further research, and, or check with their accountant.
Elimination of “Double Taxation” Problem
Elimination of the “double taxation” problem encountered in the C-corporation has been previously discussed and is fairly well known; however, there are some less well known benefits that follow:
- Because of the “Pass through” nature, S-corporations are good for profitable businesses that want to remove most of their earnings; but the pass through feature also allows for the pass through of losses to the individual stockholders personal tax returns which can be used to offset other sources of income.Many small business start ups are not profitable for the first few years, however, they do incur business expenses. This makes the S-corporation an ideal entity for this situation.
Less Well-Known Benefit of S-Corporations
- (This one is not widely known and is excellent!) In the case of a sole proprietorship, the owner will pay self employment tax on their earnings. If your business earnings are more than $400, you will need to file a Schedule SE with your personal tax return. To put things in perspective, as an employee of a company, half of your Social Security tax is paid by your employer. Now, as a sole proprietor small business owner, congratulations!; you pay self-employment tax, which is the equivalent of employee/employer Social Security and Medicare Benefits tax, better known to employees as FICA (Federal Insurance Contributions Act). This will be in the approximate amount of 15% of your earnings. Think of it this way, as the business owner you pay “both sides”. However, the key is to pay yourself a salary (as little as possible) as an employee of the corporation, and then take your share of undistributed earnings as dividends (not wages). Once again, the key is that dividends and undistributed earnings are not subject to self-employment tax (only your wages). CAUTION – the IRS requires that you pay yourself a “reasonable” salary. The savings can be substantial. For example, on a net income of $80,000, the savings could be approximately $6,000. However, remember, this “savings” is really Medicare and Social Security contributions that will be for your retirement (if you believe they will still be there when you retire).
WHAT THE IRS CONSIDERS REASONABLE COMPENSATION
There are several ways an owner (shareholder) can withdraw their earnings from the S-Corporation.
- Reimbursement of expenses
- Wages or salaries
- Distributions from the S-Corporation earnings
- Repayment of loans
The IRS assumes that an officer-shareholder who is active in the operation of an S corporation must receive wages. These wages paid must be “reasonable” (by IRS standards).
What does the IRS consider “reasonable compensation”?
- status and condition of the company such as size, complexity and profitability
- how the compensation relates to the income of the business
- cost of living where the shareholder lives
- overall employee-shareholder contribution to the S corporation
- volume of business handled by the employee-shareholder
- compensation paid to employee-shareholders of similar companies for comparable services
- the individual employee-shareholder’s abilities
The salaries and wages paid to the officer-shareholders are subject to payroll taxes (currently at about 15%)
S-Corporation Tax Strategies
See IRS Audit Tips