| Ever wondered why so many small | | | | form of tax savings because S corporations don't |
| businesses-more than 3,000,000 at last | | | | pay corporate income taxes. This means that S |
| count-operate as an S corporation? Simple. An S | | | | corporations avoid the often-talked about |
| corporation saves business owners big taxes in | | | | "double-taxation" problem. However, the "no |
| three separate ways:First, as compared to regular | | | | corporate income taxes" benefit often isn't a |
| corporations (sometimes called C corporations), S | | | | savings for small corporations and their |
| corporation owners can use the business's losses | | | | owners.But let me explain. Suppose that two |
| incurred during the early lean years on the | | | | corporations each earn the same pretax profit of |
| owner's personal returns as deductions. For | | | | $100,000 and are owned by Ms. DaVinci who |
| example, suppose a new S corporation suffers a | | | | pays the highest federal income tax rate of 35%. |
| $20,000 loss its first year and that the | | | | One corporation is an S corporation and the other |
| corporation is equally owned by two | | | | is a C corporation. The S corporation can |
| shareholder-employees, Smith and Jones. Smith | | | | distribute the entire $100,000 in profits to DaVinci |
| and Jones each get a $10,000 business deduction | | | | as dividends because there is no corporate |
| on their individual tax returns because of the S | | | | income tax. DaVinci then pays $35,000 in personal |
| corporation loss. This $10,000 deduction might | | | | income taxes on the S corporation profits, which |
| save them each as much as $4,000 in federal and | | | | means she nets $65,000 in after-tax profits from |
| state income taxes.A second, big S corporation | | | | the S corporation. In comparison, the C |
| benefit: As compared to almost every other | | | | corporation can't pay the entire $100,000 in |
| business form, S corporations can save their | | | | profits to DaVinci. The C corporation first pays |
| owners self-employment or Social Security | | | | $22,250 in corporate income taxes. When the C |
| Medicare taxes. Suppose, for example, that | | | | corporation pays the remaining $77,750 to DaVinci |
| Adams, Brown and Cole independently each own | | | | as a dividend, DaVinci pays another $11,663 in |
| businesses that make $90,000 a year in profits. | | | | 15% "dividend" taxes on the C corporation profits. |
| Each business owner may pay $13,000 in income | | | | This means that DaVinci nets roughly $66,000 in |
| taxes. But, unfortunately, that's not the only tax | | | | after-tax profits from the C corporation profits. |
| they pay. Each owner also pays self-employment | | | | In this case, DaVinci saves money with a C |
| or Social Security/Medicare taxes.For example, | | | | corporation in spite of having to pay the |
| Adams operates his business as an LLC and | | | | corporate income tax.How to Get S Corporation |
| therefore pays 15.3%, or roughly $13,500, in | | | | BenefitsTo create an S corporation and receive S |
| self-employment taxes on his profits.Brown | | | | corporation tax savings, you need to do two |
| operates his business as a C corporation which | | | | things: First, you must incorporate the business |
| pays all of its profits to him as a salary. | | | | either as a regular corporation or as a limited |
| Accordingly, Brown (through his corporation) also | | | | liability company. Second, you need to make an |
| pays 15.3%, or roughly $13,500, in Social Security | | | | election with the IRS to have the corporation or |
| and Medicare taxes.Cole's situation is different. | | | | LLC treated as an S corporation. The S election is |
| Cole operates his business as an S corporation | | | | made with form 2553, available from the web |
| which means that Cole can split his $90,000 of | | | | site. Note that some states (such as New York) |
| profits into two payment amounts: salary and S | | | | require a separate state S election.A final tip: S |
| corporation distributions. Suppose that Cole says | | | | corporations can save you thousands of dollars |
| only $40,000 of his profits are salary and takes | | | | annually, but your tax savings can't start until you |
| the other $50,000 as a "dividend" distrbution. In | | | | elect S corporation status. If you're interested is |
| this case, Carter pays the 15.3% Social Security | | | | electing S status to save on taxes for next year, |
| Medicare tax only on the $40,000 in salary. Carter | | | | you may want to call your tax advisor or |
| therefore pays roughly $6,000 in Social Security | | | | attorney right now!Redmond WA CPA Stephen L. |
| Medicare taxes-and annually saves $7,000 in | | | | Nelson is the author of QuickBooks for Dummies |
| taxes as compared to Adams or Brown.S | | | | and more than 100 other books as well. |
| corporations also, sometimes, provide a third | | | | |