Let’s dive into a topic that you’ve probably heard about: S-Corporations. This has become quite the hot topic in the online industry, and you’ve probably heard something about how becoming an S-Corp can save you money when it comes to taxes. We’re all about paying as little as legally possible in taxes, BUT it’s important to make sure you wait until the right time to become an S-Corp. Let’s break down everything you need to know about S-Corps and why they might be the secret sauce your business has been missing.
What is an S-Corporation?
An S-Corporation, or S-Corp for short, is a special tax classification that eligible corporations and LLCs can elect with the IRS. It’s not a business structure itself, but rather a tax status that can offer significant benefits to small business owners.
- S-Corps are pass-through entities for tax purposes
- They combine the limited liability protection of a corporation with the tax benefits of a partnership
- S-Corps can help business owners potentially reduce self-employment taxes
S-Corp Eligibility: Is Your Business a Good Candidate?
Not every business can become an S-Corp. Here are the main eligibility requirements:
- Be a domestic corporation or eligible LLC
- Have no more than 100 shareholders
- Have only one class of stock
- Have only allowable shareholders (individuals, certain trusts, and estates)
- Not be an ineligible corporation (like certain financial institutions or insurance companies)
The Benefits of S-Corp Status for Small Businesses
1. Tax Savings
The biggest draw of S-Corp status is the potential for tax savings. Here’s how it works:
- As an S-Corp owner, you can pay yourself a reasonable salary.
- Any additional profits can be taken as distributions.
- You only pay self-employment taxes on your salary, not on the distributions.
This setup can lead to significant savings on self-employment taxes compared to sole proprietorships or partnerships.
2. Pass-Through Taxation
S-Corps don’t pay corporate taxes. Instead, business income, losses, deductions, and credits “pass through” to shareholders’ personal tax returns. This avoids the double taxation issue that C-Corporations face.
3. Limited Liability Protection
Like regular corporations, S-Corps provide personal asset protection. Your personal savings and property are generally safe from business debts and liabilities.
Potential Drawbacks of S-Corp Status
While the benefits are enticing, S-Corps aren’t without their challenges. S-Corps require more detailed records and separate bank accounts. We recommend against doing your own books when you become an S-Corp, so you’ll need a bookkeeper (Hi, it’s us)
It also requires stricter operational processes. You’ll need to hold regular board meetings and keep minutes. The IRS requires S-Corp owners to pay themselves a “reasonable” salary before taking distributions. And finally, it requires additional tax forms. S-Corps file Form 1120S, and shareholders receive Schedule K-1s.
When Should You Consider Becoming an S-Corp?
You might want to explore S-Corp status if:
- Your business is consistently profitable – at least $75k in profits annually
- You’re paying a significant amount in self-employment taxes
- You’re comfortable with additional paperwork and formalities
- You meet all the eligibility requirements
How to Elect S-Corp Status
If you decide an S-Corp is right for your business, here’s how to make it happen:
- Form an eligible entity (corporation or LLC)
- File Form 2553 with the IRS
- Meet all state-specific requirements for S-Corp status
While these steps may seem simple, we HIGHLY recommend using a CPA or tax preparer to help you determine if it’s the right time for you to become an s-Corp, and if it is, with the filing of the paperwork. This can be a complex process, so it’s important to have an expert on your side.
Making the S-Corp Decision: Next Steps
Choosing to become an S-Corp is a big decision that can have lasting impacts on your business. Here’s what you should do:
1. Analyze your business finances to see if you’re making enough profit to benefit from S-Corp status.
2. Consult with a tax professional or financial advisor (that’s where we come in at 1428 Financial!). We can help you run the numbers and determine if an S-Corp is the right move for your unique situation.
3. If you decide to proceed, make sure you understand all the requirements and responsibilities of maintaining S-Corp status.
Ready to explore whether an S-Corp could be the right move for your business? Let’s chat! We’ll help you crunch the numbers and chart the best course for your business’s financial future. We’re not just about balancing books – we’re about helping your business thrive + making sure your numbers are working for you.
