Are you wondering if filing as an S corporation is right for your business? Depending on your circumstances and the state where your business is located, filing as an S corporation may be an efficient way to maximize tax savings while offering personal asset protection. However, with the Tax Cuts and Jobs act of 2017, most of the advantages of filing as an S corporation no longer make sense.
The plan emphasized cutting the corporate tax rate and simplifying the individual income tax system. Whether a hugely profitable multinational corporation or a sole proprietorship, every business that counts as a C corporation (or C-Corp) is now taxed at a flat rate of 21%, down from the original 35%. Further, because many LLC owners can deduct up to 20% of their business income before their tax is calculated, it can be highly beneficial to file as an LLC based on an individual’s own personal income tax rate. This could range from 10% to 37% based on each individual’s unique filing status and income level.
What Is an S Corporation?
An S corporation (Subchapter S of the first chapter of the IRS Code) is a type of business tax status that has similar tax advantages as a partnership or LLC.
If your business meets these requirements, you may be eligible for S corporation filing:
- Domestic Corporation: Most companies registered as LLCs or C corps are allowed (exceptions include sales corporation, insurance company, or financial institution).
- Shareholders: The business must have no more than one hundred shareholders, all shareholders must be U.S. citizens, and partnerships and corporations must not be shareholders.
What Are the Advantages of an S Corporation Filing?
If you live in a state that recognizes S corporation filing, making the switch could be a smart move for your business. Here are some of the advantages to filing as an S corporation.
Potential Tax Benefits (Always consult with your Tax Professional)
In most states (including Kentucky and Ohio), a company that has filed as an S corporation is considered a pass-through entity, meaning that you would file your business and personal taxes together rather than separately, thus avoiding double taxation. However, under current law, your rates may be lower at the c-corporation level.
Although the corporation would still furnish an annual information return (Form 1120-S) to the IRS, shareholders of the S corporation would report business income on their personal tax returns.
California, Louisiana, New Hampshire, New York City, Tennessee, and Washington DC tax S corporations differently. Before deciding to go ahead with an S corporation filing, check with your attorney or accountant to make sure you understand how an S corporation will be treated in your state. Recently, in most cases, filing as an LLC or c-corporation may supply more favorable tax treatment.
Like an LLC, an S corporation provides limited liability protection for the owners’ personal assets. With this type of protection, personal assets cannot be seized as the result of a lawsuit or court ruling.
Under an S corporation filing, business owners are classified as employees rather than employers. This means they can collect a salary as well as dividend income (or ownership draws).
The leftover income, or dividend distributions after paying for one’s salary, is subject to federal and state taxes, but not FICA taxes, which results in overall tax savings. Business owners or shareholders can distribute the dividend income among themselves.
In other business structures, business owners would be required to pay federal and state taxes on their salary along with the remaining income.
What Are the Disadvantages of an S Corporation Filing?
Despite the advantages of an S corporation filing, there are some disadvantages to consider as well.
- Time and effort. Filing as an S corporation takes a significant amount of time and effort due to the extra steps and paperwork involved. This can make it more expensive at least at the beginning because your legal consultations and tax assistance may cost more up front. Even for existing S corporations, filing taxes is more complicated than for other structures, so be prepared to spend more time on it.
- Constant monitoring. S corporations are subject to a lot of strict rules and guidelines, so the IRS tends to check them closely. It is particularly important to understand all the requirements beforehand and to keep detailed records to prevent your S corporation status from being rescinded.
- State laws. Not all states offer the same tax benefits for S corporations. It is best to learn your state’s regulations before making your final decision.
- Tax Cuts and Jobs act of 2017. In many cases, the tax benefits of reducing some of the payroll taxes attributed to owners and “double taxation” of c-corporations were reduced by the flattened c-corporation tax rate of 25 percent and the 20 percent deduction, in many cases, for owners of LLC’s.
The bottom line: it is important for businesses to look at their structure to make sure they are adapting to the always changing tax rules. Just be sure to weigh the pros and cons of your current corporate structure against the pros and cons of any new structure and gather all the facts before making the leap. And always consult with your tax professional.