S-Corporations Basics

A lot of people are still very confused and have little or no knowledge about S-Corporation. So it has become imperative to enlighten these people and set the record straight about the benefits, and how to qualify for an S-Corporation position. 

But we can’t dive into this discussion without first knowing the meaning of an S-Corporation. 

What is an S-Corporation 

Actually, an S-Corporation is a term used to refer to a small business corporation. So the S-Corporation election actually makes it in such a way that the owners of the business such as the shareholders to be taxed as individuals, instead of taxes being imposed on them as cooperate and as an individual.

Are you are finding the whole stuff a little complicated? Relax I will walk you through some Examples.

Benefits of S-Corporation

• The biggest benefit of having an S-Corporation status is that you have a tax position known as pass-through taxation. The concept of pass-through taxation actually entails that your company will not be taxed on its own income that is the money the company gets as income. But rather, the income of the company will be shared amongst the owners of the company (The shareholders).
• There is room for growth and business expansion in an S-Corporation setting because the company will be able to bring in investors by selling some of the company’s shares.
• The benefits of an S-corporation are great, but the fact that your business can still exist and thrive even when the owner quit, retires, or even death calls is a great and amazing benefit.
• The individual asset of shareholders in an S-Corporation is safe and well protected, in the case where your company is going through some legal issues, or being dissolved.

The benefits are great and cool, but let us take a look at some non-benefits

• There is constant scrutiny by the IRS, and this is to make sure that the payments made to shareholders conform to the required guidelines.
• The paperwork is enormous, and there is added fees required, because a lot of states require companies to pay ongoing fees, like franchise fees, or annual report fees. Though some of these fees are very small, and they are easily recouped through tax savings.
• The IRS has the legal rights to revoke the tax status of the company, they have the right to charge the company back-taxes for a period of three years, even impose additional five year waiting time, before the company can get back its tax status, but all these can happen when the company’s tax status is violated by a shareholder that does not live in the same city, and when stocks are placed in a corporate body.

So we have talked about what S-Corporation is, and on the benefits and non benefits, but what actually qualifies a business to be an S-Corporation.

So What Qualifies a Business as an S-Corporation?

When a business first files for a corporation status, the company will be first be categorized as C-Corporation, or even a single-member LLC. After that stage completes, and you meet all the necessary requirements for an S-Corporation status, then you will be elevated to an S-Corporation position.

An example of the way pass-through tax method works for S-Corporations

John Anderson is the founder of an android application building firm, with an annual profit of 1 million dollars. John Anderson formed his company as an LLC for the smooth and effective running of his Android application building business, but now he wants his company to be taxed as an S-Corporation. 

As an LLC, John Anderson is an employee of the company with an annual salary of $200,000. The $800,000 left of the company’s profit will be taken pass the S-Corporation, and then declared as S-Corporation profits on John Anderson’s personal income tax return, it will not be reported as employee salary. 

For the fact that the remaining $800,000 is not seen as the wages of the employees, both John Anderson and his company will be required to pay medicare tax, or even social security tax on the remaining amount.

So in essence, John Anderson and his corporation will only need to pay .3 in employment tax which is $200,000 x15.3 = $30,600.

At this point, all John Anderson needs to do is to pay income tax on the S-Corporation profit on $800,000. If John Anderson has not chosen to have an S-Corporation status for his LLC, then he would have paid income tax and self-employment tax on his entire profit of 1 million dollars.