S Corporations

An S Corporation is a pass-through entity that pays no business federal taxes, has shareholder liability protection, and can reduce personal, federal income taxes of the shareholders if losses are reported.

An S Corp, a subchapter S corporation,  is a business structure for a company. All S Corporations start out as C Corporations, you have to make an election with the IRS to become an S Corporation.  This election makes it a pass-through entity, which means the company itself doesn’t pay any taxes, the owners (called shareholders) do, via a Schedule K-1 form issued to the owners from the S Corp. The shareholder(s) then simply reports their share of profit and loss on their individual tax return. This prevents double-taxation, something that only shareholders of a C Corporations face… when the corporation pays federal and state taxes as well as all individual shareholders on their individual tax returns. S Corps do have state-mandated requirements, like filing annual tax returns and paying the required minimum state taxes.

S Corps have very few limitations. There can only be a maximum of 100 shareholders, all shareholders must be US citizens, and there are minimum state taxes in many states. But, S Corp shareholders pay less in federal taxes on earnings than the members of an LLC.  Since the S Corp’s earnings are not subject to self-employment taxes, the profits reported on the Schedule K-1 are taxed only at the individual’s personal tax rate (which varies from 12% to 37%) and not an additional 15.3% in self-employment taxes. So, for profits, members of LLCs pay 15.3% more than shareholders of S Corporations in federal taxes only (this does not apply to state taxes, which LLCs are not subject to).

Not making money and showing loses? No income, no problem!  Both LLC members and S Corp shareholders can offset all ordinary personal income with their losses… This reduces the adjusted gross income (AGI) of the members and shareholders, which reduces their taxable income and their tax. That leads directly to a lower tax due or an increased refund.

Both LLCs and S Corps make your expenses less expensive. A cell phone an excellent example of this. A cell phone plan that costs $100 a month is a $100 per-month expense if you run a business. If you are a W-2 employee working for a company, you are paying for that cell phone with post-tax money, so you actually need to earn $125 to cover that bill.

Essentially, for every $1,000 in business-related expenses you’re paying $250 more as a W-2 employee than you would be if you started an S Corp. These expenses include your cell phone, internet, meals, travel, electricity, and even rent.

Both LLCs and S Corps are separate legal entities. This protects you and your personal assets. The S Corp is solely liable for its debts and obligations, the shareholder of the S Corp is not. If the S Corp were to be sued by a creditor, that creditor could only go after the S Corp’s assets and not the owner’s.

NOTE: The information contained here is for general purposes to help you understand the basics. It’s not intended as tax or legal advice. Feel free to consult your own CPA or attorney to discuss your specific business questions.

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