Exploring the Tax Benefits of Establishing an S-Corporation
In the United States, S-corporations are the most popular corporate structure and have great tax benefits. There are now more than 5 million such corporations around the country. Plus, this corporate structure has achieved this popularity despite only being available since 1958.
But why is the S-corporation structure so popular these days? Most people have heard that they can lower their tax liability by restructuring. However, the truth is that there is a wide variety of different ways that an S-corporation can help businesses bring down their taxes.
Some of these tax benefits only apply in certain situations. In this article, we will look at all the ways establishing an S-corporation might be beneficial for you.
Read on to learn all about the top things to understand the tax benefits of S-corporation structures!
Save Money on Self-Employment Taxes
Some people are excited about starting a business until they find out about self-employment taxes. Self-employed business owners have to pay income taxes as well as flat taxes for Social Security and other reasons. One of the biggest tax benefits of setting up an S-corporation is that you can avoid self-employment taxes in a few different ways.
First, S-corporations enjoy pass-through taxation. That means that the income and losses of the business count on the owner’s personal tax returns.
As a result, the higher the losses of a business, the less the owner may have to pay in taxes. On the other hand, your S-corporation might provide you with an excellent profit. However, that doesn’t mean you will have to pay self-employment taxes on the entire amount of that profit.
Instead, you can pay yourself a reasonable salary while keeping the rest of that profit in the business. The final result can be paying much less in total taxes.
Although an S-corporation can help you lower taxes, it also provides several other benefits at the same time. Of course, the owner of an S-corporation does not have to pay the debts of their business out of their own personal wealth.
This business structure can also add a lot of investment appeal to a business. Many investors consider S-corporations more desirable investment opportunities. They often believe they have better growth potential and enjoy easier business management.
Avoid Double Taxation With the Right Structure
As important as these benefits are, some people think setting up an S-corporation is worth it just to avoid the double taxation problem. This problem shows up if you decide to use a C-corporation structure rather than an S-corporation one.
First, your C-corporation will have to pay corporate income taxes on business income. However, you might then divvy out that income between business owners and employees. After that, those people will have to pay their own taxes on their personal income.
This simple problem can sometimes increase payroll taxes in a ridiculous way. Depending on your situation, an S-corporation structure might be far better for you than a C-corporation one.
Some people are attracted to C-corporation structures because they limit their liability. However, S-corporations can provide the same protection while also avoiding double taxation.
Optimize Income With Salaries and Dividends
With an S-corporation, you will have the option to increase your personal wealth in two main ways. You can take out a salary or you can receive shareholder dividends instead.
Salaries and dividends are subject to different taxes. If you want to avoid the capital gains tax, you might want to focus more on taking out a salary. On the other hand, if you are less worried about capital gains taxes, you can grow your income by giving yourself dividends.
The right strategy for a given situation can vary from year to year as tax rates change. However, no matter what happens, you will be able to adjust your salary and dividends to keep your taxes as low as possible.
This kind of ownership flexibility can also make it easier to provide healthcare benefits and fringe benefits to business employees. It can even simplify the estate planning process.
Some people are used to the idea of trying to bring down their taxes by looking for deductible expenses. However, you might be able to cut your tax liability down much more in a single swoop by switching to an S-corporation structure.
Understand How States Relate to Business Structures
These general principles apply to S-corporations around the country. However, different states treat S-corporations in different ways.
For one thing, some states have minimum taxes for S-corporations. That means that no matter how small your profit, you might have to cover these minimum taxes. On the other hand, many states only tax S-corporations if they have enough income.
Some states also charge S-corporations franchise taxes or annual fees. These costs are often not about income at all. Rather, they are calculated based on the net worth of the S-corporation.
In some cases, that means the net worth of assets in the relevant state. In other cases, it means the total net worth of the corporation no matter where it holds its assets.
Invest in IRS Compliance for Maximum Benefits
Once you appreciate how amazing S-corporations are, you might wonder why they’re not even more popular. However, only certain businesses meet IRS requirements for S corporation status.
For one thing, only domestic businesses can become S-corporations. On top of that, S-corporations are not allowed to have more than 100 shareholders. The main exception is that multiple family members can count as a single shareholder.
Plus, S-corporations are only allowed to offer one class of stock. Corporations, partnerships, and non-resident aliens are not allowed to own S-corporation stock.
Enjoy the Tax Benefits of an S-Corporation Structure
Many business leaders first get interested in an S-corporation structure because they have heard that it can lower taxes. However, it can still be surprising to find out how many different ways this business structure can help bring your tax liability down. In fact, this kind of business structure was invented in the first place to help certain kinds of businesses enjoy lower taxes.
To find out more about how you can establish the right business structure for your practice, contact us at Physician Tax Solutions at any time!