Taxation of S-Corporations
An S-Corporation (S-Corp) is a business entity that offers limited liability to shareholders while aalso conferring potentially substantial tax benefits. Like partnerships, S-Corp. income passes through to shareholders in proportion to their respective business interests. Each shareholder then reports his/her proportionate share of income on their individual year-end tax return.
This is drastically different from C-Corporations, which are subject to double taxation. C-Corps. are first taxed at the entity level, for income earned by the business, and are taxed a second time when distributions are issued to shareholders in the form of dividends. When the dust settles, the same income is taxed twice.
An S-Corp., therefore, is an ideal option for most small to mid-sized businesses as it allows each shareholder to be taxed at their individual income tax bracket rate.
Tax Benefits of S-Corps.
Planning is the key to successfully reducing tax liability. Unfortunately, few businesses appreciate the importance of planning and often pay thousands of tax dollars at the expense of saving a fraction of that cost by hiring competent counsel. Numerous pathways can mitigate tax liability. Each pathway, however, begins with smart and strategic planning.
Employment tax generally refers to Social Security and Medicare Tax (FICA). The current employment tax rates are 15.3%. The employer pays half and the employee pays the other half. Utilizing the S-Corp. as a vehicle to mitigate this tax, a shareholder-employee may receive a portion of profits as a salary while designating the remainder as a return on investment. The amount designated as a return on investment escapes the 15.3% employment tax because it is distributed not as a salary, but rather, as a return on investment. This often results in significant tax savings.
A corporation is a separate entity, distinct from its shareholders. Shareholders may incur certain out of pocket costs in day-to-day operations. A shareholder may deduct these costs on his/her individual income tax return at the end of the taxable year. At first glance, this may seem to resolve the issue, however, the limitations imposed on itemized deductions must be kept in mind.
Most shareholders are owners of closely held family owned businesses. As a result, itemized deductions often do not exceed the Standard Deduction and other child/dependent related deductions. Accordingly, out of pocket costs are never deducted and do not offset income at the end of the year.
A reimbursement plan overcomes this limitation by reimbursing shareholders directly for out of pocket businesses costs.
Health Insurance and Retirement Plans
S-Corporation’s may offer employees and shareholder-employee’s health and retirement benefits that comply with the Internal Revenue Code and Treasury Regulations. Retirement accounts allow shareholder-employees in closely held corporations earning significant levels of income to direct a portion into a retirement account. This deferral can result in significant tax savings when utilized in conjunction with other planning techniques.
Contact Randhawa Hundal LLP Tax Attorneys to Learn More!
We have experienced Tax Lawyers ready to assist individuals and businesses in Sacramento, Roseville, Folsom, and the greater Sacramento area. Our Tax Attorneys can assist you with organizing your S-Corp.
Have An Attorney Call You Today