S corporation

Why Choose an S-Corporation Over LLC

• Report rights infringement
• published: 29 Aug 2016
• views: 38

S-corporations are the entity of choice for a business. We are recommending S-corporations over LLCs in most cases. They can be smooth to operate if set up correctly. An S-corporation generally pays no corporate income taxes. Instead, the items of income, loss, deductions and credits are passed through and included directly in the tax return of the shareholders. But what is an S-corporation? Technical stuff It is a corporation that issues stock, sometimes also called an electing small business corporation S refers to the code section sub-chapter S of the Internal Revenue Code There can be only one class of stock and the number of shareholders is limited to 100. Husbands and wives are counted as one shareholder. All shares must be treated equally, especially when taking distributions from the corporation How to Make an election – just putting a statement in the corporate documents does not do it Form 2553 must be filed with the IRS. It is due the 15th day of the third month of the tax year. There is a way of making a late election, which I won’t go into here. All shareholders must sign the election If married both, husband and wife must sign the election Flow-through entity A flow-through entity does not pay income tax except for 1.5% Franchise Tax to the State of California What does a “flow-through entity” mean? It means each of the income items that have different tax treatments must be reported to the shareholders as separate item. Each shareholder will receive a Form k-1 that will tell how each of the separate items must be reported. Examples are: Section 179 depreciation, charitable contributions and health insurance for the shareholder/employees Let’s talk about the similarities and differences between S Corps, Partnerships and LLCs S corporate income is not subject to self-employment tax. Partnership income generally is subject to self-employment tax as is LLC income is some circumstances. The IRS does not permit an operating S Corporation to avoid paying social security and medicare tax however. The Code require that, if the shareholders work in the business, doing a job that would require someone to be hired, the shareholder must be paid an appropriate salary, based on what would have been paid to a similar position. There is special treatment for health insurance of more than 2% shareholder – the health insurance normally is treated as a pass-through item only deductible on Schedule A, subject to the 10% medical limitation. However, for S Corporations, a shareholder can include the health insurance premiums paid for them, in their gross wages,(Box 1 of the W-2). Then the health insurance is considered self-employed health insurance, deductible on page 1 of the shareholder’s tax return. A much better result. There is a significant difference between LLCs and S Corporations for the state of California and that is the Gross Receipts tax for State of California. All entities in the state of California must pay the annual minimum franchise tax of $800. However an LLC is also subject to an additional “fee” which is determined based on its gross revenue (not net income). The fee is zero if the gross revenue is under $250,000. Between $250,000 and $500,000 of gross revenue, the fee is $900. Between $500,000 and $1 million, the fee is $2,500 and between $1 million and $5 million the fee is $6,000. So, it is possible to pay $6,800 in franchise tax and have a net loss if the S corporation has over $1 million in gross revenue. Ease of transfer of stock vs. partnership interest (or LLC) When selling a business, or transferring an interest in a business to a family member, an s Corporation is often easier than a partnership to transfer. Since an S-corporation is a corporation, a shareholder can sell or transfer the stock, instead of the underlying assets. Value still needs to be assigned to the stock, but this is often easier when considering the stock as a single asset, instead of a group of assets and liabilities in a partnership interest. Previously Taxed Income Perhaps one of the most confusing areas of S Corporations is the ability of shareholders to take distributions from the S corporation that will not be taxed. The distributions won’t be taxed because they have been “previously taxed” through the S Corporation. The detail of these transactions are summarized on page 5 of the S Corporate return in a section called Schedule M-2, Analysis of Accumulated Adjustments Account, Other Adjustments Account, and Shareholder’s Undistributed Taxable Income Previously Taxed. Lots of words for a concept that can be summarized as, the shareholder can take no more than the previously accumulated taxable income. If more than the accumulated taxable income is distributed, the distribution becomes a dividend subject to tax at the shareholder level. “Dividends” Shareholders’ Undistributed Taxable Income Previously Taxed