What is an “S Corporation” and How Can it Benefit Me?
An “S Corporation” aka “S Corp” generally refers to a type of tax treatment for a business (even a business with one owner) that usually can save the business owner(s) lots of money. Often, it allows for savings of thousands of dollars per year!
But taxes can vary significantly depending on lots of factors, so an S corp may not be appropriate for everyone. Whether an S corp is right for you is usually a question for an accountant/CPA. The actual set up of the S corp is exclusively the job of an attorney (although some accountants do the actual set up for their clients, which is generally considered an unlawful practice of law).
What exactly is an S corporation?
First let’s differentiate between legal structures and tax structures.
A legal structure is the form the business operates under, whether a formal entity – corporation, LLC (limited liability company), etc, or a “non entity” – sole proprietorship, or general partnership.
A tax structure is how the business is taxed. Here are some default tax structures:
Sole proprietorship, partnership, LLC: profits and losses “pass through” to owners, and owners pay the tax as individuals. Profits are subject to self-employment tax.
S Corporation: “pass through” taxes, as above, but “distributions” of profit to owners, above normal salary, are NOT subject to self-employment tax.
C Corporation: profits and losses are taxed first at corporate level, then when passed to owners, taxed again at individual level. (This is known as “double taxation”)
But keep in mind that the tax structure does NOT need to match the legal structure. So, an LLC can be “taxed as” an S corporation.
An S Corporation is simply a tax structure that is applied to an entity or legal structure. Despite the name, the legal structure is not necessarily a corporation at all, but could instead be an LLC (limited liability company). Once a business has formed either a corporation or LLC, it can then choose (elect) to “become” an S Corp by filing paperwork with the IRS (Form 2553).
It doesn’t really become a different type of entity at that point; it’s simply a change to the tax structure.
So an S corp can be either:
- A corporation, taxed as an S corporation
- An LLC taxed as an S corporation.
In either case, people often simply call it an “S corporation.”
How can an S corporation save me money?
With an S corporation, you can end up paying less taxes than with a sole proprietorship, partnership, “regular” LLC, or “regular” corporation. This is because all of these other entities require you to pay “self employment” tax on the full amount you earn. But with an S corporation, you can (legally) reduce your self employment tax.
For example, if you make $50,000 net income, you could save up to $3000. If you make $100,000 net income, you could save up to $8000. Serious Savings Alert!
What other benefits can I get from an S corporation?
If you are currently operating as a “sole proprietorship” or “general partnership,” you would gain additional benefits from creating an S corp. In particular, you would get “liability protection” aka “limited liability.” See more about limited liability.
So how do I create an S corporation?
Once a business has formed either a corporation or LLC, it can then choose (elect) to “become” an S Corp by filing paperwork with the IRS (Form 2553).
Talk to a lawyer and an accountant for more. See options for getting legal help.