How to Use a S Corporation to Save Thousands
Ever pondered why more than 3,000,000 small firms, according to the most recent report, operate as S corporations? Simple. In three distinct ways, a S company significantly reduces taxes for business owners:
First, S company owners can deduct business losses experienced during the early lean years on their personal tax returns, unlike normal businesses (also known as C corporations). Consider a new S corporation that has two shareholder-employees, Smith and Jones, and experiences a $20,000 loss in its first year of operation. Due to the S company loss, Smith and Jones are each eligible for a $10,000 business deduction on their individual tax forms. They might each save up to $4,000 in federal and state income taxes because to this $10,000 deduction.
Another significant advantage of S companies is that, in contrast to practically every other company structure, they may shield its owners from paying self-employment or Social Security/Medicare taxes. Assume, for instance, that Adams, Brown, and Cole together own firms that generate $90,000 in revenue annually. Taxes on income are limited at $13,000 per business owner. Sadly, though, it's not the only tax they have to pay. Each owner additionally pays self-employment taxes and/or Social Security/Medicare fees.
For instance, Adams runs his company as an LLC and as a result, he must pay self-employment taxes of 15.3%, or around $13,500, on his revenue.
Brown runs his company as a C corporation, which gives him a salary equal to all of the company's profits. As a result, Brown (via his firm) also pays 15.3% in Social Security and Medicare taxes, or about $13,500.
Cole's circumstance is unique. Due to the fact that Cole runs his company as a S corporation, he is able to divide his $90,000 in income into two payments: a salary and S corporation dividends. If Cole claims that only $40,000 of his revenues go toward paying his salary, he would receive the remaining $50,000 as a dividend distribution. Only the $40,000 in salary is subject to Cole's 15.3% Social Security/Medicare tax in this instance. In comparison to Adams or Brown, Cole pays around $6,000 in Social Security and Medicare taxes each year while saving $7,000 in taxes overall.
Because S companies don't have to pay corporate income taxes, they may provide a third method of tax savings. Thus, S companies avoid the frequently discussed issue of double taxation. However, for small businesses and their owners, the benefit of no corporate income taxes is frequently not a cost-saving measure.
But allow me to clarify. Assume that Ms. DaVinci, who pays the highest federal income tax rate of 35%, owns two firms that each make a pretax profit of $100,000. The first company is a C corporation, whereas the second is a S corporation.
Due to the absence of a corporate income tax, the S corporation is able to pay DaVinci the whole $100,000 in earnings as dividends. DaVinci then pays $35,000 in personal income taxes on the S corporation's revenues, leaving her with an after-tax profit of $65,000. The C corporation, in contrast, is unable to pay DaVinci the whole $100,000 in earnings. First, the C corporation must pay corporate income taxes of $22,250. DaVinci must pay an additional $11,663 in 15% dividend taxes on the C corporation income when the C corporation distributes the remaining $77,750 to it as a dividend.
How to Receive Benefits from S Corporations
You must do two things in order to form a S company and save money on taxes: The company must first be incorporated, either as a standard corporation or as a limited liability company. To have the company or LLC classified as a S corporation, you must secondly file an election with the IRS. Form 2553, which is accessible at the IRS website at www.irs.gov, is used to make the S election. Be aware that certain states (like New York) demand a separate state-level S election.
One more piece of advice: S corporations can help you save thousands of dollars yearly on taxes, but the benefits won't begin until you choose to become a S company.