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The Basic of S-Corporations

The Basic of S-Corporations

A business's success depends on a good business structure because the impact comes in the long run. The consequence of neglecting a business structure is tremendous. The structure handles the business future, its running, management, tax, and legal matters. Ensure you research before jumping into one. 

However, this article will focus on the basics of S-Corporation.

What Is an S-Corporation?

An S-Corporation performs the same functions as other corporations except when it comes to tax payment. S-Corporation limits its liability tax to its stakeholders instead of the usual federal income tax. Subsequently, the S-Corporation is taxed once and the profit and losses are shared according to shares in the corporation. The profit made by the business is recorded as income. In summary, any other corporation will be taxed twice.

IRS has guidelines for establishing an S corporation and is strictly followed to avoid huge penalties and misunderstandings. Here are the guidelines:

  • Must be based in the United States.

  • Must have only certain shareholders like trust funds, individuals, and estates; but must not include partnership, non-resident, or corporation.

  • Must not have more than 100 shareholders.

  • Must not qualify for other corporations such as insurance, financial institutions, and domestic or international sales corporations.

After structuring an S corporation, Form 2553 will be given to the shareholders for signing to receive the S Corporation site. Afterward, the cooperation partners can handle the tax payment structure.

Advantages of an S-Corp Structure

Avoiding Double Taxation

IRS exempts an S-Corporation from paying taxable income, making it appealing and an edge over other corporations. Generally, corporation taxable income is expected to be taxed twice – corporate and individual income tax level. The income, loss, deduction, and credits operated in the corporation are filed via the shareholders to address tax matters. The shareholders filed the report exactly as received as an income tax return titled Form 1040. Form 1040 is considered and taxed with the same rate as individual tax. This case exempts them from double taxation by the IRS.

Sadly, the rule is not applicable in all states in the US. Some states, like New York City, impose an 8.85% income tax on all corporations, except the business has other branches located outside the state. On the other hand, states like California impose a 1.5% tax on net income or a payment of $800, which is considered a franchise tax.

Self-Employment Tax

Another advantage of S-Corporation is that the business can decide to lower self-employment tax by dividing it into salary and distribution. The S-Corporation sets the taxable income, which makes it adjustable. By splitting the income tax, the IRS only levies on salary, thus reducing the overall tax liability. 

The shareholders enjoy the second part income as distribution. This aspect is not taxable by law. The division has caused a saving for the corporation and reduced overall tax by approximately 60% on the business income. 

 

The Bottom Line

The S-Corporation has a strong stand in the United States because of tax savings and limited liability. The business can easily be transferred and continue running without any tedious paperwork. More people are seeking to explore the opportunity, and the business has risen to 4.6 million companies in the United States. 

However, before setting up an S corporation, read the rules and regulations, especially on the tax payment structure in your state. You can hire a lawyer to oversee the process and render advice on structuring the cooperation for more understanding.


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