S Corporation Benefits

How to Save Taxes with an S Corporation

S corporation can save business owners taxes in roughly three ways

S Corporation Benefit 1:

As compared to regular C corporations, S corporation owners can use the business’s losses—such as those incurred during the startup phase—on their personal returns as deductions. Note that this “S corporation advantage” is also shared by single member and multiple member limited liability companies (LLCs) electing default treatment.

S Corporation Benefit 2: As compared to almost every other business form, S corporations can save their owners self-employment or Social Security/Medicare taxes.

S Corporation Benefit 3 A final possible benefit: As compared to regular corporations, S corporations sometimes save owners taxes because S corporations don’t pay corporate income taxes. (This means that S corporations avoid the often-talked about “double-taxation” problem.) But the “no corporate income taxes” benefit often isn’t a savings for small corporations and their owners.

S Corporation Benefits Example

Suppose that two corporations each earn the same pretax profit of $100,000 and are owned by Donna who pays the highest federal income tax rate of 35%. One corporation is an S corporation and the other is a C corporation. S corporation can distribute the entire $100,000 in profits to Donna as dividends because there is no corporate income tax. Donna then pays $35,000 in personal income taxes on the S corporation profits, which means she nets $65,000 in after-tax profits from S corporation. In comparison, C corporation can’t pay the entire $100,000 in profits to Donna. C corporation first pays $22,250 in corporate income taxes. When C corporation pays the remaining $77,750 to Devlin as a dividend, Donna pays another $11,663 in 15% “dividend” taxes on the C corporation. This means that Devlin nets roughly $66,000 in after-tax profits from C corporation. In this case, Devlin saves money with a C corporation in spite of having to pay the corporate income tax.

Be Aware - Your tax savings can’t start until you elect S corporation status. If S corporation status saves you money, therefore, it’s possible that each month of delay costs you several hundred dollars in extra taxes.

To qualify for S corporation status, the corporation must meet the following requirements:

Be a domestic corporation

Have only allowable shareholders including individuals, certain trust, and estates and may not include partnerships, corporations or non-resident alien shareholders

Have no more than 100 shareholders

Have one class of stock

Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international sales corporations.

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