Tax Tips for Sub S Corporate Structures
Tax Tips for Sub S Corporate Structures When There is a Distribution, the distributions are tax-free. Distributions include amounts previously taxed.
The Complete Guide to S Corporation Taxes
S corporation status is a tax designation granted by the IRS that lets corporations pass their income through to their shareholders. (You might also sometimes hear S corporations referred to as “Subchapter S corporation,” “Small Business Corporation” or simply “S corp.)
Will filing for S corp status result in a lower tax bill for your corporation? Or should you remain a regular corporation? And how exactly does reporting the profits or losses of an S corp on your tax return work?
Here are Tax Tips for Sub S you need to know.
How are Tax Tips for Sub S?
S corps do not pay corporate income taxes, so there is not an “S corp tax rate.” Instead, the company’s shareholders split up the income (or losses) amongst each other and report it on their tax returns.
Unlike regular corporations (“C corporations”), this lets S corps avoid double taxation.
Double taxation refers to how income earned by a regular corporation is technically taxed twice: once when the corporation earns income, and again when it distributes dividends to its owners (who then pay taxes on those dividends).
S corps avoid this business tax bypassing their income through to their business owners directly (therefore they are sometimes referred to as “pass-through” entities).
How do I elect S corp tax status?
To file (or ‘elect’) for S corp status, your business must first be incorporated as a regular C corporation or have filed for LLC status. (Remember: S corp status is a tax designation—you cannot ‘incorporate’ as an S corp.)
Tax Tips for Sub S If you are electing S corp status as a C corporation, you must submit Form 2553, Election by a Small Business Corporation to the IRS, signed by all your company’s shareholders.
If you are electing S corp status as an LLC, you will need to file Form 8832, Entity Classification Election.
Get a detailed breakdown of how to elect for S corp status with the IRS.
How do I file my taxes as an S corp?
Form 1120S, U.S. Income Tax Return for an S Corporation is the tax form S corporations (and LLCs filing as S corps) use to file their federal income tax return.
The 1120S is a five-page form from the IRS, which looks like this:
You will need the following Tax Tips for Sub S on hand before filling out the 1120S:
General information about your business, including your date of incorporation and the date you elected S corp status
- Your business activity code and your Employer Identification Number (EIN)
- A profit and loss statement and a balance sheet for your business
- Information about any payments you made to independent contractors totaling at least $600 for the year (each of whom you should have sent a 1099 form)
Page one of the 1120S is divided into four parts:
- The top third of the form containing fields A-F is where you will input your contact information, dates of incorporation and S corp election, your assets, etc.
- The Income section will ask you about all your company’s revenues for the year, which is information you will get from your income statement.
- The Deductions section is where you will record all your business’ deductible expenses for the year, which you will also get from your income statement (and hopefully have receipts for).
- The Tax and Payments section applies to corporations that began the year as a C corporation and filed for S corp status during the current tax year. You will use this section to list any estimated taxes you paid during the year and calculate any taxes you owe or overpaid due to the switch. (This can happen if your C corp earned passive income or sold assets at a profit this year.)
There are also six schedules attached to 1120S, the first three of which are mandatory:
Schedule B, “Other Information,” will ask you a series of yes or no questions about your business’ accounting methods, the types of stock it owns, gross receipts, and a bunch of other stuff.
Your answers to Parts a) and b) of Question 11 are particularly important here—if you answer “yes” to both, you will not have to fill out Schedules L and M-1 of Form 1120S.
Schedule D is where you will report any capital gains or losses your S corporation sustained this year (i.e., money it made buying or selling stocks, bonds, and other assets).
Schedule K brings together information about your business’ income, deductions, and any tax credits your business qualifies for. You will use the information you bring together on this schedule to file a separate Schedule K-1 for each shareholder in your S corp, based on the percentage of total shares they own.
There are also three optional schedules attached to 1120S:
Schedule L gives the IRS a snapshot of your business’ assets, liabilities, and equity, and you will use your company’s balance sheet to complete it. Schedule L only must be filled in by businesses that either a) had more than $250,000 in receipts this year, or b) held more than $250,000 in assets this year. (Schedule B will ask you about this.)
Schedule M-1 is where you will report any discrepancies between the profits (or losses) you reported in your books, and the profits you reported on your taxes (due to depreciation or any tax-exempt interest you earned, for example).
Schedule M-2 is where you’ll report changes in your company’s retained earnings, i.e. any profits you held back to reinvest in the business.
Further Tax Tips for Sub S reading: What is Form 1120S, and How Do You File It?
When is the deadline for filing my S corps’ taxes?
The deadline for filing Form 1120S is March 15, 2021. You can also apply for a six-month extension by filing Form 7004. You can file both forms electronically and by mail.
What are the tax benefits of filing as an S corp?
No double taxation
As we mentioned above, regular corporations are taxed at the corporate and personal level, while S corporation income is only taxed at the personal level. If your company is making a profit and you want to take some of those profits out of the company, it is generally cheaper to do so as an S corp.
No self-employment taxes
Unlike owners of sole proprietorships, partnerships, and LLCs, S corp owners only pay self-employment taxes on their wages rather than their entire share of the company’s profits. All other income is paid to shareholders in the form of “distributions” that are not subject to self-employment tax, which makes S corporation status very attractive to many small businesses.
For example, let us say you have a 50% ownership stake in Carl’s Sandwiches, a successful chain of sandwich shops that recently filed for S corporation status with the IRS.
As CEO and founder of Carl’s Sandwiches, you earned a $60,000 salary in 2019, and the company also earned a net profit of $200,000 that year, which you are entitled to 50% of—or $100,000.
Because Carl’s Sandwiches is an S corp, you will only have to pay self-employment tax on the $60,000 salary and not on the $100,000 distribution.
But there is a catch
You may wonder why S corp owners do not just take a salary of $0 to avoid self-employment taxes altogether.
The catch here is that if you are a shareholder and an employee of the company, which most small business shareholders are, you must pay yourself a “reasonable salary” before paying yourself a tax-free distribution.
What exactly is a reasonable salary? The IRS has no hard and fast rules for this one. But you should try to base it on position, experience, business size, and what a comparable position at another company in your industry would earn. Whatever salary you decide on, be sure you can justify it to the IRS if you ever get audited.
Also: watch out for different state rules
Tax Tips for Sub S, while these tax advantages might make S corporation status attractive, S Corps are not treated equally by each state. For instance, some states choose to follow the federal tax requirements for S corps, while states like New Hampshire, Tennessee, and Texas ignore S corporation status and tax those companies as C corporations.
Chat with a CPA or tax professional to make sure you are aware of your state’s S corporation rules.
So, should I elect S corp status?
This decision should come down to whether you plan on taking profits out of your business or reinvesting them back into your business.
Filing as an S corporation can lower your tax bill if you (or any other owner) plan on taking profits out of the company in the form of distributions.
If you’re a new and growing business and intend to reinvest most of your profits back into the business, on the other hand, sticking to C corporation status can leave you with a lower tax bill.
For more on whether C corp or S corp status is right for your business, check out our breakdown of S corps vs C corps. And if you have decided to become an S corp, we’ve got a guide to the forms you need to fill out.
And as always, you should not make any drastic tax move like this before consulting a CPA, tax attorney, or another expert that has expertise in tax planning. They will be able to tell you definitively whether S corp status is right for your business situation.
And if you want someone else to take care of the bookkeeping and tax filing for your S corp, check out Bench. We will take everything off your plate, for good.
Choosing between an LLC, S Corporation, or C Corporation?
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