Your choice of entity and tax treatment for your business is one of the first decisions that you will make regarding your company, and it should be with care. Like any business decision, the key to making the right choice is having the right information.
The first major step in choosing your tax treatment is selecting a business entity for your operations. You have four main choices:
- Sole proprietorship
- C corporation
- S corporation
To determine whether the S corporation is the right entity structure for your business, you have to know how it compares to your other options. The two main benefits of operating your business as an S-Corporation is relief from double taxation, and savings on employment taxes. If you are simply looking for liability protection, then single member LLC can be a less costly and complicated alternative.
If you own a C corporation, the government taxes both you and your corporation. First, the corporation pays income tax at corporate rates. Second, you as a shareholder pay tax on the dividend you receive from the corporation. S corporations pay taxes only once. An S corporation is a pass-through entity, which means that the S corporation does not pay taxes. Instead, the income, deductions, and tax credit items skip the layer of corporate tax and flow through to taxpayers via a K-1, onto their individual tax returns.
The main reason businesses or individuals choose an S-corporation tax structure is to realize tax savings on employment taxes. When you operate your business as an S corporation, you are both a corporate employee and a shareholder. As an employee, you receive a wage or salary to compensate you for the work you perform. As a shareholder, you receive distributions for your ownership stake in your S corporation. The salary paid to you as an employee is subject to employment tax. Your shareholder distributions are not. Since you set your own salary as the owner of the S-Corporation, you determine how much of the income generated by your business is subject to employment tax.
Tax planning and industry financial expertise is critical in this area. Setting your salary too low exposes you to risk of IRS examination which can result in payment of unpaid employment taxes and hefty penalties and interest. Setting your salary too high leads overpaying taxes. Over the course of your business’ life, the overpayments of tax and lost investment opportunities can cost you hundreds of thousands of dollars.
Monthly clients at Camuso CPA receive an annual in depth analysis of reasonable compensation. Our team of CPA’s is constantly gathering support from every level of legislative and administrative tax authority. This is essential and should be offered by the CPA advising you. More on reasonable compensation studies here: http://bit.ly/CamusoRC
S corporations offer significant tax benefits to business owners and investors, but impose extra costs onto owners which must be considered when assessing the S-Corporation tax structure for your business. To obtain the tax benefits of an S-corporation structure, you will have to work closely with a CPA during the year on tax planning to ensure you are taking the correct measures to minimize your taxes. As previously mentioned, an annual in depth analysis of reasonable compensation is required to substantiate your wage levels in the corporation. Additionally, S corporation tax returns are more time intensive and complex than a personal tax return and S corporations create extra tax-related paperwork each time you take money out of the corporation, so this is an additional administrative cost to consider.
All too often, we acquire clients at Camuso CPA who were oversold on the tax benefits of an S corporation, unaware of the additional associated costs, and are rushed into a costly entity structure. Be sure that your CPA or advisor can specially explain the costs and benefits to you before electing S corporation status for your business.
Camuso CPA PLLC’s focus and specialization delivers a unique perspective on best industry practices to provide the most value to clients. Contact us today for financial and tax planning and get your finances in order: https://www.camusocpa.com/contact/#/