An S-Corporation isn’t necessarily a business entity in itself. Instead an S-Corporation is a business that is already formed (C-Corporation or LLC) and elects to be taxed differently. This election has strict requirements that must be followed in accordance to IRS Codes.
The company must be a domestic corporation, can have no more than 100 shareholders and can only have one class of stock. More importantly, when choosing the S-Corporation election, owner-employees are required to pay themselves a “reasonable salary” in order to perform their daily duties in the business. And as you can assume, the IRS has not given us a definition or guidelines to determine what a “reasonable salary” means.
The most common reason for a company to elect the S-Corp status is the advantage to its taxation. Income from the business is passed through to the shareholders/members, who in turn report the income on their personal tax records.
With the S-Corp election, the owner-employee pays him/herself a “reasonable salary” which the business will pay payroll tax. The owner, at the end of the year, will then take the profits as a distribution which is not subject to self-employment taxes.
When deciding if your business would benefit from the S-Corp election, it’s highly advised that you discuss your options with an accountant or an attorney who can guide you through the process.
If you’re interested in learning more about the benefits and downfalls of an S-Corporation, check out our blog post Choosing a Business Entity.
Contact Howard Haake at (314) 325-9868 or (636) 332-5555 for more information about choosing which business entity is best for your business.