There are several tax benefits once you decide to have your business become an S Corporation. It saves the double taxation issues that a shareholder in a corporation normally encounters. You can avoid Social Security and Medicare taxes which self-employed folks pay every tax season as well. In other words, an S Corporation is taxed in a different way compared to corporations. It is more like partnerships that are considered as a pass-through entity which means no federal income tax levied at the corporate level and the profit is taxed according to each shareholders profit share. Another example of how passing through of tax items happen on S Corporations, is whenever it donates money to a certain charity. It is going to be reported as a charitable donation on the Schedule K-1 and the shareholders, with their portion of the donation, will include it to their itemized deduction for charity. All items of income, deduction, and tax credits are therefore appropriately reported on the each of the shareholder’s personal tax return.
The Social Security and Medicare taxes paid by self-employed individuals called self-employment taxes, on the other hand, are generally higher compared to people who are employees of the company. Although it’s important to remember that the IRS will take a closer look at your taxes if you chose to organize your business as an S Corporation. This type of business or business entity may lower your total tax liability while earning the same net income as well. You are allowed to choose how can you can be taxed, whether through a corporate level or shareholder level, so you might as well take advantage of this privilege if it works for you.
Federal Income Taxes For S Corporations
Since an S Corporation is considered a pass-through entity, the tax is therefore passed by the owners for the sake of paying federal income tax. The corporation will file a corporate tax return using the Form 1120S. Each of the shareholders will then share the profit or loss of the business which will all be recorded in Schedule K-1. You will find each of the shareholder’s K-1 information on Line 17 within the shareholder’s Form 1040. State tax most of the time also utilize the federal information to collect taxes from the total income of the corporation.
Other Taxes S Corporations Pay
Once you decide to elect an S Corporation status for your business, you also have to be aware of the other taxes the corporation needs to pay such as the following:
S Corporations Disadvantages
Although S Corporations, in general, does offer tax benefits on your part, it has a share of risks too. The IRS follows a thorough investigation in the company because of a huge potential abuse. Avoiding a high amount of self-employment tax can trigger an IRS inquiry. To lessen this possibility of this situation from happening is through designating a “reasonable amount” of your income as wages instead of using it as a distribution. The term “reasonable” can be hard to determine but it is definitely something you should strictly apply to avoid an IRS audit and possible penalties or interests on back taxes. You have to consider that an S Corporation also has a start-up and ongoing legal and accounting costs which could be a burden to your business rather than save money from your tax liabilities.
As you study the above factors on how S Corporations are taxed, you should be able to determine by now if this type of business status suits you well in terms of fulfilling your tax liabilities to the IRS. Before you make any decision, make sure to consult a tax professional to enlighten you on this matter to avoid tax issues in the future.
