Why You Should Consider Registering Your Business as an S Corp
There are numerous designations for businesses. The right one for your company will depend on many factors, including your size, the number of owners, and more. However, if the option is available to you, you may want to consider filing to register your business as an S corporation. Doing so can provide you with numerous tax benefits. Keep reading to learn more about what an S corp is, what the benefits of becoming one are, and whether or not it may be right for you.
What Is an S Corp?
The IRS defines an S corporation as a corporation “that elect[s] to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.” Simply put, becoming an S corporation changes the way your business is taxed. Instead of being taxed as a separate entity, as C corporations are, an S corporation passes income, losses, etc., down to its shareholders, who are assessed tax on their individual returns.
What’s the Benefit?
So, what’s the tax benefit of filing to make your business an S corp? Most businesses that are registered as S corporations experience significant savings on their taxes. Without this designation, your business may be taxed for the income it receives; then, every partner would be taxed when that income is paid out to them as well. Becoming an S corporation allows your business to avoid double taxation on corporate income.
If your business operates as a single-member LLC or partnership, the business’s income isn’t taxed; like with an S corporation, the individual owner or partners simply report their share of the company’s income and are taxed on their personal returns. However, in these types of businesses, the owner or partners not only pay their standard tax rate—they’ll have to pay an additional self-employment tax. For 2020, that would be an additional 15.3%.
Owners in an S corporation, on the other hand, are only taxed at their usual income tax rate, and the self-employment tax is waived completely. You can imagine just how much removing that 15.3% tax can save you every year.
Paying Yourself a Wage
The reason that owners in an S corporation are able to avoid that self-employment tax is because they are actually making themselves W-2 employees of the business. If you elect to receive an S corporation designation for your business, you will have to pay yourself what is known as an “officer’s wage” each year. You’ll set your own salary at the beginning of each year and issue yourself a paycheck, just as you would for any employee. That wage will then be listed as a business expense.
If your business has multiple partners or owners, each one will receive an officer’s wage through a regular paycheck. Each will also receive a W-2 reporting that income when tax season rolls around.
It is essential that you continue to pay yourself this wage each year in order to remain compliant with IRS regulations for S corporations. If you do not do this and are audited, you can face large fines and penalties against your business.
Is It Right for Your Business?
While filing to become an S corporation benefits many small-business owners, it isn’t right for everyone. First, you must ensure that you meet all of the following IRS requirements to become an S corp:
- Be a domestic corporation
- Have only allowable shareholders (individuals, certain trusts, and estates)
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (this includes certain financial institutions, insurance companies, and domestic international sales corporations).
If you meet these requirements, getting an S corp designation for your business may offer you significant savings on your taxes every year. However, we still strongly recommend that you consult with an accountant who is familiar with handling business taxes before you proceed. A business tax accountant will be able to discuss the pros and cons of switching your business designation in more detail and help you to decide what’s right for your company.
If you would like to discuss whether or not becoming an S corporation is right for your business, contact us to schedule a consultation today. We’ll go over the decision with you in great detail and, if you decide it’s right for your company, help you to request the change in your business’s designation. Give us a call to schedule your appointment today.