S Corp Tax Advantages: Everything You Need to Know
S corp tax advantages refer to the unique advantages that S corporations enjoy with regard to taxation under the Internal Revenue Service (IRS). 3 min read
S corp tax advantages refer to the unique advantages that S corporations enjoy with regard to taxation under the Internal Revenue Service (IRS). One of the main tax advantages for S corporations is pass-through taxation, which allows S corporations to avoid being subjected to the double taxation that C corporations typically face.
What Is An S Corporation?
An S corporation is not considered a true type of corporation. Rather, an S corporation is just a regular corporation or a limited liability company that has made the election for Subchapter S, a tax designation, with the IRS. This designation can have a significant impact on how much an entity pays in taxes, how it deals with profits, and how it distributes shares.
The S corporation is one of the most popular choices for individuals thinking about incorporating their businesses. The other two most popular choices are C corporations and limited liability companies.
One key difference between an S corporation and a C corporation is that there is no double taxation at the corporate and the individual shareholder level.
On the other hand, S corporations, just like other corporations, are made by filing the articles of incorporation with a government body like the Secretary of State. S corporations are governed as corporations and can issue stocks. S corporations have officers, directors, and shareholders. These roles are the same as the corresponding roles within C corporations.
The shareholders, also referred to as owners, of an S corporation enjoy the same liability protection as the owners of a C corporation. This means that the personal assets of a shareholder of an S corporation cannot be seized to satisfy any liabilities of the business. Personal assets encompass homes, personal bank accounts, and cars.
S Corporation Advantages: Protected Asset
Lack of protection from personal liability can lead business owners to lose their personal wealth and assets like their cars, homes, savings, and retirement investments. The court-recognized, distinct existence of S corporations protects individuals from personal liability.
Without a personal guarantee, a shareholder will not be held responsible personally for the debts of the business or the corporation's liabilities. Creditors are not permitted to pursue the house, bank accounts, or other personal assets of a shareholder to pay any business debts.
S Corporation Advantages: Pass-Through Taxation
S corporations do not have to pay federal taxes at the entity level. The vast majority of states follow the federal guidelines. You should take a look at the Ongoing Corporation Requirements for your state to determine whether your state actually recognizes S corporation election at a federal level.
Business losses and income that are "passed through" to the shareholders can be reported on their individual income tax returns. This means that the losses of the business can offset other income on the tax returns of the shareholders, reducing the amount of taxes due.
Pass-through taxation can be very helpful for businesses that are in the startup phase. If a corporation does not choose S corporation status and accumulates income passively, it can be deemed as a personal holding company.
S Corporation Advantages: Tax-Favorable Characterization of Income
The shareholders of an S corporation can do all of the following:
- Serve as employees of the corporation
- Receive salaries as employees
- Receive income in the form of dividends from the business
- Receive other distributions that are free of taxes to the extent of their basis, or their investment in the business
The shareholders of S corporations can also be employees of the S corporation and can earn salaries as employees. Employee-shareholders can also receive income in the form of dividends from the S corporation. These employee-shareholders are eligible to receive other distributions that are tax-free to the extent of their basis, which is a number that represents the amount they have invested in the corporation.
Owner-operators can decrease self-employment tax liability by distributing some income as salary and other income as dividends. However, this distribution needs to be reasonable. Under the guidelines of the IRS, employee-shareholders need to receive competitive salaries as employees. The reason for this guideline is to prevent S corporations from paying unreasonable salaries to decrease payroll taxes.
If you need help with S corp tax advantages, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.