There are many things to consider when forming a new business.
Among these, one extremely important factor to consider is how the entity should be structured. A business’s structure will clearly determine how it will operate. However, the structure will also affect how much a business and its owners pay in taxes, sometimes significantly so.
The federal taxes that a business will pay vary depending on the structure of the entity. Some business structures allow income to pass through the business to be taxed as individual income of the owners. Other businesses have to pay corporate tax and tax on distributions.
One such business structure that has a notable impact on how the business pays taxes is known as an S corporation or S Corp Designation (added to an LLC).
The business structure commonly referred to as an “S corporation” or “S election” is actually a status achieved by combining a common business structure with a special tax designation granted by the IRS that allows the business’s income to pass through to shareholders or members.
An S-Corp Designation is mostly commonly added to a corporation or LLC that makes a valid election to be taxed under Subchapter S of the Chapter 1 of Internal Revenue Code.
An S-Corp receives different tax treatment that can be more favorable to a business owner depending on the net income of the business and other factors. A S-Corp election also offers the business owner the beneficial ability to pay themselves a reasonable salary, which is affiliated to payroll taxes. What that means is that an owner’s withdrawals or dividends taken out of the company, above and beyond a reasonable salary are free of payroll taxes.
Business owners should keep in mind that not all business entities can chose this election S-Corp. There are certain requirements that must be fulfilled. In order to apply for S-Corp status, your business must first satisfy the following requirements:
- It must be a domestic business entity;
- It must have only “allowable” shareholders or members
- It must have only one class of stock or membership interest
Among other requirements
While the tax advantages of an S-Corp make it attractive for businesses, S-Corps also have some drawbacks. Ultimately, the determination of whether an S-Corp designation is right for your business will depend on a closer analysis of your business needs and structure. Consulting with an experienced attorney and tax professional will ensure that all requirements are met and the designation is in the best interest of your business.