Should You Elect S-Corporation Status? Any advantages?

August 27, 2008

Setting up a proper entity type is very important aspect of starting your business. As a business owner you should consider whether or not it makes sense to set up a LLC, S – Corporation, C Corporation or just run your business as a sole proprietor. As our effort to educate and train you from various aspects of setting up a correct entity type we would like to show you as to why an S Corporation may be right from you. Apart from liability protection perspective we would like to discuss the advantages an S – Corporation carries from tax prospective.

If your business currently operates as an LLC, a partnership or a sole proprietorship, then your profits are subject to self-employment taxes. As an S Corporation, only your salary is subject to self-employment taxes.

Here are the S – Corporation advantages:

Forming an S-Corporation generally allows you to pass business losses through to your personalincome tax return, where you can use it to offset any income that you (and your spouse, if you’re married) have from other sources.

 When you sell your S-Corporation, your taxable gain on the sale of the business can be less than it would have been had you operated the business as a regular C corporation.

The first $102,000 (for TY 2008) of salary that a person earns is subject to self-employment taxes of 15.3%. Half of this is paid by the employer and half by the employee. Of course, if you own your own business, then you are both employer and employee.

Salary in excess of $102,000 (for TY 2008) is subject to the Medicare tax rate of 2.9%. Again, half is paid by the employer and half by the employee.

If you operate as an LLC, a partnership or a sole proprietorship, then your profits are treated as salary, meaning you pay taxes per the above on all your profits.

If you operate as an S Corporation, then you only pay the above taxes on money you take as salary.

Let’s look at a simple illustration.

John is a sole proprietor bringing in sales of $100,000. After he pays his costs & expenses, his profit is $70,000. As a sole proprietor, he is required to pay self employment tax of 15.3% on this entire $70K of profit, which equates to $10,710.

Now, let’s assume John formed an S-Corporation for his business, and chooses to pay himself $40K for the year in salary, and take the remaining $30K of profit through a distribution. He still earns the same $70K in profit.

But, let’s look at the tax situation. Because corporations only pay Social Security & Medicare taxes on salaries, he’s only liable for $6,120, saving over $4,590 in taxes!

 

 

Sole Proprietorship (Schedule C)

S-Corporation

Sales

$100,000

$100,000

Cost & Expense

$30,000

$30,000

Salary

 

$40,000*

Profit

$70,000

$30,000

 

 

 

Self Employment Tax

$10,710

N/A

Social Security & Medicare

N/A

$6,120**

Total Tax Savings

 

$4,590

* You pay yourself Salary for the efforts you put for the organization

** Pay Taxes only on your Salary not Profit

Many businesses are initially started as LLCs, partnerships or sole proprietorships because of the ease of setting them up. This completely makes sense but switching to an S Corporation is not that complex, so look at your business situation and make the change when the time is right. (Contact www.mybizfiler.com for additional details)

It is important to note that you are required to take “reasonable” compensation as salary when you operate as an S Corporation as per the IRS circular. This will be effective if you act in the capacity of officer / manager or employee for your business. (Contact www.mybizfiler.com for additional details)

Fortunately, a decision to elect to be an S-Corporation isn’t permanent. If your business later becomes more profitable and you find there are tax advantages to being a regular corporation, you can drop your S- Corporation status.

You may contact Incorporation & Accounting Professionals at ICS, Inc (www.mybizfiler.com) if you need help on Incorporating an S Corporation or changing the status of your C Corporation, LLC, LP, LLP, or Sole proprietorship.

ICS can help you and your business. ICS, Inc (www.mybizfiler.com) offers a wide range of services typically offered by a Big 5 Accounting firm and a CPA firm in the U.S. ICS offers Incorporation, Book Keeping, Payroll Services, HR & Business Consulting etc.  Contact ICS today at 203 437 4083, e-mail – sales@mybizfiler.com, or by accessing 24/7 chat page on www.mybizfiler.com

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The contents of this post are personal statements or opinions expressed by Umang Thakkar, Associate Vice President, ICS Inc. They must not be construed as financial, investment or taxation advice.


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