How To Save Taxes With An S Corporation

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