Forming an S Corporation: Is It the Right Structure for You?

Forming an S Corporation: Is It the Right Structure for You?

Forming an S Corporation? The Subchapter S Corporation or simply s corp is not a separate and distinct entity from a general corporation. Rather, it is a tax election only. But this tax election enables the owner or owners to handle profits or losses as distributions and to have them pass through directly on their personal tax returns. There is a catch with specific rules. If the owner or owners are working for the company, they must pay themselves wages before they can distribute profits. Consult with your lawyer or tax accountant before making your final choice.

These wages must meet a certain standard–what is called “reasonable compensation.” That is, if you are president of the company, you cannot pay yourself a dollar a year in salary and then pay yourself the rest of the profits. If you would have to hire someone for $100,000 a year to fill your shoes, then that is what you must pay yourself. If there are any profits left after that, they can be treated as profits to pass through on your personal tax return, but you must check with your accountant before determining any of this. This can vary by region and occupation. If you do not handle this properly, the IRS can reclassify all profits from the company as wages and you will have to pay payroll taxes on the entire amount.

Forming an S Corporation: The Advantages

You can pass through profits and losses to your personal tax return.
You have limited liability, as with a traditional corporation, without having to pay corporate taxes.
You might not have to pay payrolls taxes on the entire earnings of the company but you need to check with your accountant on IRS rules.

Forming an S Corporation: The Disadvantages

The IRS keeps a close eye on employee-shareholders to make sure they are taking the proper salary
Owners of these companies must uphold numerous tax rules.
S Corporations are as costly to set up as a regular corporation.
All shareholders must be U.S. citizens.
Employee benefits are not necessarily deductible in full.
All shareholders must vote in favor of an S or C.

Although it is only hearsay and you need to check with your accountant or tax professional, the businesses that we have interviewed that are S Corporations do seem to undergo a different level of scrutiny by the tax authorities than other companies, although we must point out that we have never seen any studies that bear this out. There seems to be a concern by tax officials that employee-owners will try to lower their share of payroll taxes by taking a low salary and then passing through higher earnings on their tax returns. Therefore, it is important to check with your accountant before setting up such a corporation. Although this structure might fill your needs, there are other options for you to consider as well such as an LLC.

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