With the tax season upon us, we’d like to help shed some light on tax issues. Every Friday for the next several weeks we will discuss how the following tax considerations apply to different business entities. (Look for the little piggies!) The considerations are:
- Pass through of gains
- Pass through of losses
- Transfer of assets to the entity, and
- Transfer of assets from the entity
This week we’re going to cover the S-corporation.
What is an S-corp?
For starters, an S-corporation starts just like a normal C-corporation. The letters (S & C) are designations from subchapters of the IRS code. Most corporations are C corporations. An S corporation is a corporation that has made a special election to be taxed in a certain way. Because of this special treatment, there are additional rules and restrictions on top of the standard corporate law requirements.
The requirements unique to an S-Corp are:
- Be filed as a US corporation
- Have only one class of stock
- Have no more than 100 shareholders
- Shareholders must: be individuals, estates, or qualified trusts which consent to the election
- The shareholders must be U.S. citizens
If you qualify based on the criteria above, the S-corp could be a good choice for you. These are general rules, and may or may not be applicable to your specific situation. Please consult a licensed advisor before making any decisions based on the following.
1. Pass through of Gains
With an S-corp election an entity can avoid the double taxation found with C-corporations. An S-corp passes gains through to the shareholders. Therefore, any profit of the corporation shows up on the shareholder’s personal income tax return. While the company doesn’t necessarily have to pay the money out to shareholders, the shareholder is still personally liable for the gains. Gains are distributed pro-rata; in proportion to a shareholder’s ownership.
2. Pass through of Losses
An S-corp does allow shareholders to recognize losses on their personal income taxes, which are also distributed pro-rata. C-corporations are not able to pass losses through to shareholders. However, LLC’s are more flexible with the structure of how losses that are passed through. (Check back later for more info!)
3. Transfer of assets to the entity
In this respect, an S-corp is treated just like a C-corp. Depending on the ownership percentages of the entity, a shareholder may be able to transfer assets to the corporation without triggering a taxable event. Generally, if you own 80% or more of the shares at the time of the transfer then it is not taxable.
4. Transfer of assets from the entity to shareholders
While a transfer of a corporate asset to a shareholder is a taxable event, gains or losses are passed through to that shareholder. This is different from a C-corp which would be taxed twice (at the corporate and personal level). A transfer from an S-corp is only taxed once; a tax for which the shareholder is responsible.
Additionally, the S-corp also has special benefits for the self employed. In an S-corp, there are two streams of income to employee-owners: wages, and distributions. An owner of an S-corp is automatically deemed an employee and must be paid reasonable wages. Anything beyond reasonable can be taken as a distribution, and not subject to the 15% (or higher) employment taxes. This could possibly save a small business owner hundreds or thousands per year.
Also, don’t forget that the deadline is quickly approaching for S-corps!
Now is a great time to gather your documents and head for your CPA or Attorney to make a difference before tax day, April 17th! If you are interested in learning more, or filing your S-corporation today, start here.