Unlocking the benefits: Top reasons to own an S corporation
The business world is filled with opportunities and structures designed to streamline operations, minimize tax liabilities, and improve profitability. Among them, the S Corporation (S Corp) stands out as a compelling option for many business owners. Known for its unique tax advantages and operational flexibility, this type of entity offers a path to significant savings and strategic business growth as a legal entity. One of the key requirements for an S Corporation is to have a board of directors and corporate officers, which helps with internal practices and formalities such as drafting corporate bylaws. Having a board of directors and corporate officers is crucial to maintaining proper governance and ensuring compliance with state corporation laws in the United States.
Choosing an S Corporation structure isn’t just a tax decision. It’s a strategic step toward a more streamlined and efficient business operation. As businesses face the complexities of taxes and rules, knowing the benefits of an S Corporation can help them save money and better follow the rules. But what exactly is an S Corporation and why might it be the right choice for you? In this article, we’ll explore the various reasons why an S Corporation structure could benefit your business. It highlights how this choice can help your business grow and stay strong.
What is an S Corporation?
An S Corporation, also known as a Subchapter S, refers to a special tax designation granted by the Internal Revenue Service (IRS) that allows small businesses to pass through corporate income, losses, credits, and deductions to their shareholders for federal tax purposes. This designation helps avoid double taxation on business income, a common problem in the traditional C Corporation structure. Named after subchapter «S» of the Internal Revenue Code, an S Corporation combines the legal environment of a corporation with the tax efficiency and operational flexibility of a partnership or sole proprietorship, making it a highly beneficial business structure for small businesses. It is an alternative to the limited liability company (LLC).
Here’s how it works:
Limited liability
Like a traditional corporation, an S Corp provides its owners (shareholders) with limited liability protection. This means that shareholders’ personal assets are typically protected from business debts and liabilities.
Transfer taxes
An S Corporation does not pay federal income taxes at the corporate level like a regular C Corporation does. Instead, it passes through its profits and losses to shareholders’ personal tax returns, using tax forms such as Form 1120-S. Shareholders are then taxed at their individual income tax rates, allowing them to offset corporate losses against income from other sources. This setup avoids double taxation, which occurs with C Corporations. In a C Corporation, the corporation pays taxes on its profits, including any passive income, and then shareholders pay taxes again on the dividends they receive. This pass-through tax structure, a key benefit of having S Corporation status, allows for more favorable tax treatment for shareholders.
Property Restrictions
There are certain restrictions on who can be shareholders of an S Corporation. For example, an S Corporation is restricted to a maximum of 100 shareholders, all of whom must be U.S. citizens or residents.
Structural requirements
To elect S Corporation status, the company must first establish itself as a regular C Corporation or be eligible to do so. Shareholders must then file Form 2553 with the IRS to elect S Corp status.
S corporations are popular with small and medium-sized businesses. They offer liability protection to a corporation while also avoiding double taxation. They do have some limitations and requirements that must be met to maintain their status.
The Advantages of Choosing an S Corporation
Selecting an S Corporation as a preferred business entity offers numerous benefits to small business owners. One of the main advantages is avoiding double taxation, a common problem faced by traditional C Corporations. In a C Corporation, the corporation pays taxes on its profits at the corporate level and shareholders pay taxes again on the dividends they receive.
However, by registering as an LLC and choosing S Corp status, small business owners can save on personal income tax since they can characterize their income as salary or dividends. This can result in less liability for self-employment tax, making it a popular choice among LLC owners and small business owners in general. Additionally, LLC owners can also enjoy the tax benefits of the Tax Cuts and Jobs Act, similar to S Corp owners, making it a favorable choice for business structure.
In contrast, S corporations allow profits (and losses) to pass directly through to shareholders, who then report the income on their personal tax returns. This structure not only simplifies the tax filing process but also provides more favorable tax treatment for business profits.
Top Reasons to Have an S Corporation Structure
Here are some of the top reasons people might choose to structure their business as an S Corporation:
Reducing the owner’s salary: a strategic approach
One of the most effective methods for reducing personal payroll taxes revolves around strategically reducing your salary as an S Corp owner. By reducing your inflated income, you can allocate a portion of your income as distributions, which are exempt from self-employment taxes. However, it is crucial to maintain a level of “reasonable compensation” to avoid triggering an IRS audit. This strategy may also be applicable to limited partnerships or limited liability companies, depending on the industry and specific circumstances.
To determine this sweet spot, meticulously document your responsibilities within the corporation and assign appropriate hourly wages for each role you take on, whether administrative, managerial, or operational. Support your analysis through comprehensive corporate minutes, strengthening your position should the IRS ask about your justified salary. By taking this strategic approach, you can significantly minimize your personal payroll taxes while ensuring compliance with IRS regulations.
Coverage of homeowner’s health insurance premiums
As the owner of an S corporation, you can deduct health insurance premiums for yourself and your immediate family by following specific IRS guidelines. Set up a health insurance plan through your corporation, either through direct premium payments or reimbursements to you. Be sure to include these premiums as wages on your W-2 form so you can claim the self-employment health insurance deduction on your personal tax return.
However, this deduction is contingent on you and your spouse not being eligible for employer-sponsored health coverage. Additionally, the premiums cannot exceed your S Corp salary to qualify for the deduction. By taking advantage of this benefit, you can not only provide health insurance coverage for yourself and your family, but also enjoy tax deductions that can significantly reduce your overall tax liability.
Employing your children: a double-win strategy
Employing your children within your S Corp can yield two-fold advantages. While you must pay payroll taxes on their wages, you can shift income from your highest tax bracket to your lowest bracket, potentially saving on overall taxes. Plus, you can contribute to their future financial security by channeling their earnings into retirement or education savings accounts.
Each child can earn up to $12,200 (in 2019) without incurring federal income taxes, providing an excellent opportunity to build up your savings tax-free. Be sure to document your legitimate work responsibilities to substantiate your wages and avoid potential deduction denials during an audit.
By employing your children, you not only provide them with valuable work experience, but you also enjoy tax savings and the opportunity to secure your financial future.
Selling Your House to Your S Corp
If you’re thinking about converting your primary home into a rental, here’s a smart idea: Sell it to your S corporation first. This move helps you avoid taxes on the sale by using the home sale exclusion, which can be up to $500,000 for married couples. Plus, it increases the depreciable basis of the property, which will allow you to take larger tax deductions in the future.
Here’s how it works: Let’s say you sell your home to your S corporation for $750,000, but your basis (what you paid for it) is $250,000. You can use the $500,000 home sale exclusion to avoid taxes on the $500,000 gain. At the same time, your property’s new depreciable basis becomes $750,000. This means you can claim more substantial depreciation deductions on your taxes later.
This strategy helps you save on taxes while still owning your property and earning rental income through your S corporation. It’s beneficial for your finances.
Deduction of central office expenses
As the owner of an S corporation, you can save money by deducting some of your living expenses through a home office cost reimbursement. Here’s how it works: Follow IRS rules in Regulation Section 1.62-2(c). You must submit reports listing your home office expenses, obtain reimbursement through your corporation’s chart of accounts, and view this reimbursement as a nontaxable employee business expense.
To qualify for this deduction, your home office must be where you primarily work and earn income. You must show that you use your home office exclusively and regularly for business purposes. Keep detailed records to back this up, especially in case of an audit. By deducting these home office expenses, you can reduce your taxable income and save money on personal and business taxes.
Renting Your House to Your S Corp
If you’re not willing to turn your home into a rental property, you can still take advantage of a tax-saving strategy by renting it out to your S Corp for up to 14 days a year. The corporation can deduct the entire rental amount, allowing it to accumulate income completely tax-free. Be careful, however, to refrain from renting out your home for entertainment purposes, as the entertainment facility rule does not allow such deductions. Instead, validate the rental by hosting business meetings, staff retreats, or board meetings, making sure to document ordinary and necessary business activities with photographs and date stamps.
Renting your home to your S Corp provides a win-win situation. Not only does it generate tax-free income, but your corporation can also deduct rental expenses, reducing your taxable income. However, it is critical to ensure that the rental agreement is properly structured and documented. Consult with a tax professional like Akron Income Tax Co to ensure compliance with all tax laws and regulations.
Using a responsible travel expense plan
As an S Corp owner, you can reimburse yourself for business-related travel expenses through an accounting plan. You can get tax-free reimbursements for expenses such as airfare, car rentals, lodging, meals, and incidentals by filing complete expense reports that substantiate the business purpose of your travels. This helps you reduce your taxable income while ensuring proper accounting for your business-related expenses.
It’s important to note that if you own more than 10%, you cannot use the per diem method to make reimbursements; instead, you must claim actual expenses incurred. Keep thorough records of your travel expenses, including receipts and itineraries, to support tax-free reimbursements. By taking advantage of a responsible plan, you can enjoy the benefits of tax-free travel reimbursements while also complying with IRS regulations.
Refund of mobile phone charges
The IRS recognizes the importance of smartphones to business needs, allowing S corporations to reimburse their employees for cell phone expenses without incurring taxes. To benefit from this, you can submit your monthly cell phone bills through your company’s accounting system. It’s critical to ensure that the reimbursement reflects reasonable coverage costs and does not replace regular wages.
To stay compliant, it’s important to distinguish between personal and business use of your cell phone. Keep thorough records of business-related calls and activities, and if possible, maintain a separate business line. By reimbursing cell phone expenses through your S Corp, you can save on taxes while staying connected and productive in your business activities.
Taking advantage of Section 179 and depreciation bonus for vehicles
If you’re purchasing a large vehicle (weighing more than 6,000 pounds) for your business, you can get some great tax breaks. Section 179 allows you to write off up to $510,000 (in 2019) of the cost if it’s for business use. For SUVs between 6,001 and 14,000 pounds, there’s a $25,000 limit. Additionally, new large vehicles can qualify for a 50% depreciation bonus on what’s left after Section 179. This can really reduce the amount of taxes you have to pay the year you buy the vehicle.
If your business is structured as an S Corporation, you’ll get even more tax benefits. You can use Section 179 and bonus depreciation to write off a large portion of the vehicle’s cost, meaning you pay less tax. This can be a big help for businesses that rely on vehicles, such as delivery or construction companies. So if you’re thinking about acquiring a vehicle for your business, being an S Corporation could save you a lot of money on taxes.
Maximizing retirement contributions
Contribuir a cuentas de jubilación antes de impuestos es una forma inteligente de reducir sus ingresos sujetos a impuestos. Si es propietario de una S Corp y no tiene empleados además de su cónyuge o sus hijos, piense en establecer un 401(k) individual para maximizar sus contribuciones de jubilación y sus ingresos netos. Puede aportar hasta $ 56 000 (límite de 2019) cada año e incluso hacer una contribución Backdoor Roth sin tener que lidiar con reglas de prorrateo. Esta puede ser una estrategia valiosa para maximizar sus ahorros para la jubilación y al mismo tiempo reducir potencialmente sus ingresos imponibles mediante el uso de beneficios de seguridad social. Además, esto puede ayudar a aumentar sus ingresos netos y su estabilidad financiera general a largo plazo.
Si quieres contribuir más que el soloLímite 401(k), podría considerar un Plan de Pensión de Beneficios Definidos. Le permite realizar contribuciones de seis cifras y aún realizar contribuciones Backdoor Roth. Hable con un asesor financiero para determinar el mejor plan de jubilación para su situación.
Ahorrar todo lo que puedas para la jubilación es crucial para cualquier propietario de negocio. Con los beneficios de jubilación de una S Corp, puede planificar su futuro mientras reduce sus impuestos. Esto le brinda tranquilidad y le permite concentrarse en hacer crecer su negocio, sabiendo que sus ahorros para la jubilación van por buen camino.
Deducción de donaciones caritativas
Si bien las donaciones caritativas de S Corp se deducen a nivel de accionista en su declaración de impuestos personal, considere “agrupar” sus donaciones durante varios años. En lugar de hacer contribuciones anuales, consolide las donaciones de dos o más años en un solo año. Esta estrategia puede potencialmente elevar sus deducciones detalladas por encima del umbral de deducción estándar, generando ahorros fiscales.
Como propietario de una corporación S, tiene la oportunidad de realizar donaciones caritativas y recibir beneficios fiscales personales. Al “agrupar” sus donaciones, puede programar estratégicamente sus contribuciones para maximizar sus ahorros fiscales. Concentrar sus donaciones en un solo año fiscal puede superar el umbral de deducción estándar, lo que podría amplificar sus deducciones detalladas. Es recomendable consultar a un asesor fiscal para garantizar el cumplimiento de las regulaciones del IRS y optimizar sus contribuciones caritativas de manera efectiva.
Preguntas frecuentes
¿Cuáles son las ventajas de formar una S Corp?
La formación de una S Corp brinda protección de responsabilidad limitada a sus propietarios, evita la doble imposición al transferir las ganancias a los accionistas, permite ahorros de impuestos mediante deducciones, ofrece credibilidad a la empresa y puede atraer inversores potenciales debido a su estructura.
¿En qué se diferencia una S Corp de otras entidades comerciales como LLC y C Corps?
S Corporations, or S Corps, differ from other business entities like LLCs and C Corps in terms of taxation. S Corps have pass-through taxation, meaning that profits and losses are passed through to the shareholders’ personal tax returns. This prevents double taxation at both the business and individual levels.
How does the profit distribution process work in an S Corp?
In an S Corp, profits are distributed according to the percentage of ownership each shareholder owns. This means that if a shareholder owns 30% of the company, they would receive 30% of the profits. This distribution must be accurately documented to comply with IRS regulations.
When to change from LLC to S-Corp?
Transitioning from an LLC to an S-Corp is generally recommended when your business starts generating higher revenues, usually around $70,000 or more in profit. S-Corps offer tax advantages for businesses with higher profits, so it’s a smart move to switch once you reach that revenue threshold.
Conclusion
Choosing an S Corporation structure for your business can yield a wealth of benefits, from tax savings to liability protection. By renting out your home to your S Corp, utilizing a responsible travel expense plan, reimbursing cell phone expenses, taking advantage of Section 179 and bonus depreciation for vehicles, and deducting charitable donations, you can take full advantage of the opportunities an S Corp provides. However, it’s critical to consult with a qualified tax professional to ensure compliance and optimize your tax strategy. So why wait? Discover the benefits of an S Corporation structure today and get your business on the path to success.