The S corporation is a tax classification created by the IRS to help small businesses. This tax classification allows LLCs and C corporations to avoid double taxation through what is known as pass through taxation. Double taxation occurs when corporate income is taxed once at the corporate level and then once more at the individual level. Pass-through taxation allows business owners to pass through their corporate income onto their personal tax returns and as a result only need to pay tax once on this income.
TRUiC’s Tax Calculator and S Corporation Requirements
The election of S corporation status allows LLC owners to be taxed as employees of their own business. This allows owners to pay less in self-employment tax and it allows owners to contribute to their 401k and health insurance with pre-tax dollars. TRUiC’s S Corp tax calculator will help entrepreneurs to determine whether electing S corporation tax status will result in a tax saving for a business. There are two important steps which an entrepreneur should complete before using the tax calculator. First an entrepreneur should determine what a reasonable salary is for the work which they do. This can be done on a website like Glassdoor or using information provided by the US Bureau of Labor Statistics. Secondly an entrepreneur should make a conservative estimate of their net profit for the year. This estimate should be conservative as it should be a number that a business is able to reach every year.
There are certain requirements which a business must meet in order to be able to elect S corporation status. These requirements are: no more than 100 shareholders in the business, only one class of stock, the LLC or C corporation is domestic, the owners are all US citizens or permanent resident aliens and the owners are all private individuals and not other companies. Additionally, the IRS has specific deadlines which must be met for the election of S corporation tax status. If an owner would like their business to become an S corporation in the following year they may apply any time in the previous year. If an owner would like S corporation status in the same year they can submit no later than the 15th of March that year. For new businesses the owners must file within 2 months and 15 days after they start their company. This date is based on the effective date on the Certificate of Incorporation.
There are also criteria for whether it makes sense to elect S corporation status for a business. The business must meet the IRS requirements as elaborated previously. The business owner or owners must earn a reasonable salary on a consistent basis. The business owner or owners should be able to pay themselves at least $20,000 in distributions. Finally, the tax advantage must offset the costs of maintaining the S corporation.
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If an LLC elects to become an S corporation, the owners become employees of the company. Under the rules laid out by the IRS the owner must be paid a reasonable salary. This means a salary that someone else performing the same role would normally earn. The IRS checks to ensure that the S corporation is paying the owner a reasonable salary. If a company is not doing this, the company may be denied S corporation status, need to pay a fine and possibly be required to pay back taxes.
The IRS charges small fees to elect to become an S corporation. There are also additional costs associated with becoming an S corporation such as bookkeeping and payroll costs. Some businesses may already be paying these costs in which case this does not factor into becoming an S corporation. Due to the additional administrative costs, the tax advantages of electing to be an S corporation must be significant enough for the S corporation election to make sense. In a general sense the paying of a reasonable salary plus $20,000 in annual distributions is sufficient to save money on the tax return.
The election of S corporation tax status can be very beneficial for entrepreneurs as they can potentially make significant savings on their tax returns. However, this will not always be the case. That is why the TRUiC tax calculator can be a massive help to entrepreneurs who are considering electing S corporation tax status but are unsure of whether this would be beneficial for them. Additionally, business owners should be aware of all the requirements and deadlines which are associated with becoming an S corporation.