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S Corporation – A Comprehensive Guide to Filing Taxes
An S Corp (small business corporations) has a number of advantages. It offers investment opportunities, the much sought after protection of limited liability and perpetual existence. Additionally, it has to file taxes yearly instead of the usual quarterly for C Corp and is not subjected to double taxation – once as corporate income and again as dividend income. S Corp, therefore, does not have to pay self-employment tax on net income. In spite of these advantages, S Corp taxation can get complicated if there are shareholders earning a salary throughout the year.
Filing of taxes by S Corp
At the basic level, An S Corp has to file Schedule K-1 as well as Form 1120S. Things change if there are shareholders drawing the salary because in that case, the S Corp has to file routine payroll taxes too that is inclusive of Federal Taxes deducted from employee paychecks, FICA taxes, and unemployment taxes. Payroll taxes have to be reported in Forms 940 and 941.
If as an S Corp you find all these a bit confusing, opt for payroll software for small businesses. It will automate such processes as calculating paychecks and computing payroll taxes as well as transferring of payroll data to payroll tax forms so that you do not have any problem in filing returns and paying taxes on time.
Tax filing Forms for S Corp
Here is a list of tax forms that have to be filed by S Corp along with a brief description of each.
- Form 1120S – A comprehensive return to be filed for reporting all income, deductions, credits, and losses of the business.
- Schedule K-1 – It is used to report shareholder’s share of net income on an individual and personal tax return. This form passes through income, deductions, credits, and losses to its shareholders.
- Form 940 – All employers have to file this form annually to report payments made under head unemployment taxes.
- Form 941 – This form has to be filed quarterly for reporting income tax and FICA taxes collected from employee salaries. The share of the employer has to be included in this form too.
Tax advantages of an S Corp
There are some tax benefits that can be had by an S Corp and is the reason why many business owners currently LLCs that are taxed as sole proprietorships or partnerships actively consider switching to S Corp status. The advantages are –
- No double taxation – An S Corp does not have to face “double taxation”, that is its revenue is not taxed at the corporate level. Tax is levied only when it pays salaries or dividends to shareholders. A C Corp, on the other hand, is taxed on its net revenue as well as on earnings distributed as dividends.
- No self-employment taxes – An S Corp does not have to pay self-employment tax on its net earnings. Instead as an owner of an S Corp, you can draw a salary and share the cost of Medicare taxes and Social Security which are known as FICA taxes with your company.
To better understand this point about S Corp tax advantages, a comparison of the pros and cons of S Corp, C Corp, and LLS tax will be in order.
Pros – There is no double taxation and shareholders can lower quantum of taxes by drawing a salary. If a business is running at a loss, the tax bill will be lower. Taxes are also based on individual tax rates which are lower than corporate tax rates. Finally, shareholders are not subjected to self-employment tax.
Cons – An S Corp has to pay FICA Taxes for wages to owners drawing a salary and also has to pay unemployment tax.
Pros – The burden of taxes on net earnings is on the corporation and not on the shareholders who do not have to pay self-employment tax either.
Cons – A C Corp comes under “double taxation” and shareholders cannot reduce taxes by drawing a salary. Further, tax rates are on corporate slabs and this could lead to an increased tax bill.
LLCs considered as a sole prop or partnership
Pros – There is no “double taxation” and overall tax rates are on individual tax slabs and not corporate tax brackets which are higher.
Cons – Owners have to pay self-employment tax on net earnings.
The S Corp taxes and obligations mentioned here are based on the tax structure at the Federal level only. Each State has its own laws in this regard. For instance, an S Corp is taxed similar to a C Corp in New Hampshire, Tennessee, Texas, Louisiana, and the District of Columbia.
Is it beneficial to be an S Corp
It makes sense to opt to be an S Corp in the initial stages of a business when startup costs eat into earnings leading to losses. The tax bill will be reduced significantly as it is possible for an owner to offset income on a personal tax return with the share of losses from S Corp. It also pays to be an S Corp when its tax bracket is lower than what corporate taxes are. This happens because individual tax rates are paid by an S Corp on net earnings whereas C Corp would be paying corporate taxes.
Once you find that it is beneficial to be an S Corp you have to know your eligibility. You can convert to S Corp status if you are a domestic company with individuals as shareholders not exceeding 100 in numbers. However, there are restrictions on financial institutions, insurance companies and domestic international sales corporations switching to S Corp status.
If you meet all the above criteria you can take steps to become an S Corp by completing Form 2553 and submitting it not more than 2 months and 15 days after the beginning of tax year when the transfer is to take place.
Take professional help
Being an S Corp and garnering all the tax benefits is generally the chosen option for business owners but it is always advisable to take professional help for tax preparation and other accounting solutions. There are two reasons for this. First, any error in tax prep committed even accidentally can lead to termination of S Corp status. Second, since salaries or dividends to employees and shareholders are taxed differently, it often leads to a close scrutiny by IRS on the distribution.
If you need the help of experts in taxation and accounting, Cogneesol should be your first choice. We have years of experience in tax preparation and our accountants are well conversant with all nuances of the law as laid down by IRS. So while you offer top of the line client services, we will take care of your tax processing functions. All data is transmitted on fully encrypted lines for added safety and security and we use only recognized software relevant to your country.
For more information, write to us at [email protected] or call +1-646-688-2821. You will be more than happy with our services.
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