For those not aware: S CORPORATION is a tax election which can be elected by an entity for specific taxation purposes.
They are corporations that choose to “pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.
S corporations are responsible for tax on certain built-in gains and passive income at the entity level.”
One of the biggest reasons why business owners choose to elect this status is because it can save a business owner on Social Security and Medicare taxes, since their Distributions are not subject to Payroll Taxes – just the normal Income Tax, by itself.
S corps are not a “one-size-fits-all” pathway to being a millionaire, as some Social Media might have you believe.
Generally, if your business is not generating enough profit to cover all business expenses, payroll systems, wages, and taxes– then an S Corp election will cost you more than it earns you..
This is because the compliance expenses (Payroll, Employees, Tax & Reporting costs, etc.) can be more or nearly as much as the tax savings.
Additionally, the penalties for non compliance are higher, stricter, and less forgiving than they are for sole proprietors – if you have any issues with reporting or compliance, this entity change is something you’ll likely need a professional’s assistance with, or one you might avoid entirely.
For example, an owner who is both an employee and a shareholder in an S Corp must pay themselves via a Salary and/or Distributions.
The Salary is also necessary if the owner performs more than minor services for the business.
Even if you don’t hire employees immediately, and it’s just yourself, you’ll automatically become an “Employer” in many State jurisdictions – since you will become an Officer (Employee) of your S Corp.
Even if you don’t pay yourself a wage, you would be responsible for filing an Employer’s tax return to the State and the IRS – even if reporting “0.00” wages. Failure to do so results in increasing penalties!
Federally, the 940 Return is due annually, while the 941 is due quarterly.
State Employer’s returns vary by State: many follow a quarterly schedule, and some have parameters to file less often based on certain qualifications.
Major Payroll Processors (like ADP) provide a platform which withholds both Employee and Employer taxes from employee (W-4) paychecks, remits the funds immediately to State/IRS, and files all necessary payroll returns automatically.
In closing: if you’re considering the S Corp tax election, it’s critical that you have the following:
Steady, higher Net Profit
Proper bookkeeping records
Consistent tax returns filed
A Payroll Processor or system in mind
Knowledge about “Employer” tax returns and taxes
Separation of Company and personal finances
Ability to pay oneself from the Company at a set rate
The addition of these new types of tax returns and compliance requirements can quickly indebt a Company before it has a chance to become successful. It is imperative you do your research, consult a professional, and be prepared for the requirements in order to enjoy this tax election!
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