By Tony Wimperis
Considering S Corporation status can bring substantial tax advantages, such as avoiding self-employment taxes and navigating pass-through taxation at federal and state levels. Optimal entity selection is critical, as this decision involves tailored tax planning due to individual circumstances.
Here's what opting for an S Corporation entails:
Self-Employment Tax Savings
Owners who are also employees of S Corporations can lower their self-employment tax burden. Instead of subjecting the entire business income to both employer and employee FICA (12.4%) and Medicare (2.9%) taxes, only the owner's reasonable salary is subject to these taxes. This eliminates FICA and Medicare taxes on distributions (payments) to the owner above their salary.
Pass-through Taxation
S Corporations operate as "pass-through" entities, channeling business profits and losses to shareholders' tax returns. This often leads to lower taxes compared to standard corporations, i.e., C Corporations, where earnings face double-taxation of the same earnings – once at both the corporate level and then at the individual shareholder levels in the form of dividends.
Single-member LLCs transitioning to S Corporation status will make them eligible for state pass-through entity taxes. In this scenario, the tax on business income will be paid by the business instead of directly by the owner - thus relieving the individual from paying the tax. This shift makes the state taxes fully deductible as business expenses, allowing business owners to avoid hitting the $10,000 state income tax deduction limit (the SALT Cap) on individual tax returns.
To qualify for S Corporation status, businesses must meet these criteria:
- Formation in the United States
- No more than 100 shareholders
- One class of stock or units
- Owned by U.S. citizen/resident individuals, specific trusts/estates, single-member LLCs, or other S Corporations. Partnerships and C Corporations don't qualify.
If S Corporation status aligns with your goals, the federal election must be filed within two and a half months after the start of the intended first S Corp tax year. Alternatively, you can file the election anytime in the previous tax year.
Remember, this decision requires careful planning. Reach out to an R+R tax advisor today for guidance.
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve. Our mission is to operate as a financial services firm of outstanding quality. Our efforts are directed at serving our clients in the most efficient and responsive manner possible, delivering services that exceed the expectations of those we serve. The firm has offices at 90 Grove St., Ridgefield, Conn., and 51 Locust Ave., New Canaan, Conn. For more information, please contact Elizabeth Bresnan at 203.438.0161 or email.
