Many people wonder whether their company should be taxed as an S corporation under Subchapter S of the Internal Revenue Code. There is a lot of misinformation and confusion about the S election. This brief article will go over some basic S-election considerations for business owners.
Whether a business owner has a C corporation or a limited liability company, the business owner can elect for their company to be taxed as an S corporation. This is done by the filing of a tax form with the IRS making the election. This filing should be made by the business owner’s attorney or accountant.
S-elected entities have favorable self-employment tax treatment, which can mean a tax savings for the owners of the company. Like the usual taxation of a limited liability company, an S-elected entity is a pass-through entity, meaning that any income earned by the company is passed through to its owners. Contrary to a C corporation or a limited liability company, there are limitations on the number and types of shareholders. The S corporation also may only have one voting class of stock. The timing of when the S election is filed can have a big impact on when the S election can become effective.
With an S-elected entity, a tax savings can result where a business owner’s salary is less than the net income of the company. For example, if the company’s net income is $100,000 for a particular tax year, and the sole business owner’s salary is $30,000, then the business owner would pay income tax on $100,000, but would only pay self-employment tax on $30,000. This would be a tax savings of $10,710, which is $70,000 multiplied by the current self-employment tax rate of 15.3% for salaries not exceeding the wage base for the tax year the S-election is effective.
The business owner’s salary should be set forth in a written employment agreement prepared by your attorney. The business owner’s salary must be reasonable, meaning that after considering several factors, it is approximately the fair market value for the services provided by the owner in that market. If a business owner is ever audited by the IRS, the business owner will be glad to have the written employment agreement, as it is one of the things the IRS looks for in deciding whether the salary is reasonable.
The above are only some of the considerations in deciding whether your company should elect to be taxed as an S corporation. Business owners should consult with their attorney or tax advisor before making a final decision.
J. Brian King is an experienced business attorney and can be reached at https://businessattorneylaw.com/.