An S corporation is a special type of business entity that offers several tax benefits. By setting up your company as an S corporation, you not only reduce the amount of self-employment taxes you pay on company earnings, but also avoid double taxation on company profits. This means you won’t have to pay personal income tax again when you file your personal return.
If you have decided to start a business and get into entrepreneurship, one of the first decisions that comes your way is choosing the right legal structure for your venture. While there are pros and cons to each type of business entity, the S corporation has some significant advantages for many small business owners. An S corporation—also known as a “pass-through” entity—is a kind of corporation with few formal requirements and no stockholders.
It’s perfect for small businesses because it helps owners manage their own businesses without incurring double taxation from their company and personal income taxes. As an S corp, you won’t be required to pay self-employment taxes (social security and Medicare), which can add up to around 15% in some states. Here is how you can set up an S corporation:
What is an S Corporation?
An S corporation is a type of business entity that allows owners to pass their profits and losses to their personal income tax return. Shareholders in an S corporation don’t get taxed on the company’s earnings.
Therefore, S corporations can be attractive to small business owners who want to minimize their tax liability and have flexibility to reinvest company earnings in their businesses. An S corporation can be formed by a for-profit business with no limit on shareholders.
To qualify as an S corporation, the business must also meet certain criteria set by the IRS, such as: – The business must be organized as a corporation. – Shareholders can’t be nonresident aliens. – Shareholders can’t be entities or individuals who directly or indirectly have ownership interests in other S corporations.
How to Form an S Corp
You must form a corporation before you can apply for S corporation status. If you already have an existing corporation, you can apply for S corporation status as long as the company: – Has been in business for at least one year – Has no more than 100 shareholders – Has only one class of stock – Has been conducting business as a corporation – Has not changed its business nature or the industry it operates in If your existing corporation meets these criteria, you can apply for S corporation status by filing a simple application with the IRS and paying a $325 fee. S corporation status is valid for two years and can be renewed without the need for additional documentation.
Advantages of Starting an S Corp
Reduced Self-Employment Taxes – By becoming an S corporation, you can reduce your self-employment taxes. That’s because you’ll be paying federal and state income taxes on your income as an employee, instead of as an owner of a business. – Avoid Double Taxation on Company Profits – Since S corporation profits aren’t taxed on the company level, you won’t have to pay personal income taxes on the money when you file your taxes each year.
This saves you the time and money required to file a Schedule C or Form 1040. – Manage Your Cash Flow Better – S corporations have built-in cash flow management tools that allow you to pay yourself a salary and make distributions to your shareholders when needed.
Disadvantages of Starting an S Corp
You have to have a separate bank account for the business. – You must have enough cash flow to pay yourself a salary. – You have to file a separate tax return for the business. – You can’t contribute to an individual retirement account. – You’re required to pay double social security and Medicare taxes.
Key Takeaway
If you’re looking for a simple, low-cost business structure, the S corporation might be the best option for you. S corporations are exempt from some of the requirements and fees that accompany more complex business structures.
Although S corporations have many benefits, there is no one-size-fits-all solution when it comes to choosing the right legal structure that works best for your business. You should carefully consider several factors before making a decision, such as your business’s tax status, the type of work you do, and the amount of money you expect to make in the first year.