| Ever wondered why so many small businesses-more | | | | provide a third form of tax savings because S |
| than 3,000,000 at last count-operate as an S | | | | corporations don't pay corporate income taxes. This |
| corporation? Simple. An S corporation saves business | | | | means that S corporations avoid the often-talked |
| owners big taxes in three separate ways:First, as | | | | about "double-taxation" problem. However, the "no |
| compared to regular corporations (sometimes called C | | | | corporate income taxes" benefit often isn't a savings |
| corporations), S corporation owners can use the | | | | for small corporations and their owners.But let me |
| business's losses incurred during the early lean years | | | | explain. Suppose that two corporations each earn the |
| on the owner's personal returns as deductions. For | | | | same pretax profit of $100,000 and are owned by Ms. |
| example, suppose a new S corporation suffers a | | | | DaVinci who pays the highest federal income tax rate |
| $20,000 loss its first year and that the corporation is | | | | of 35%. One corporation is an S corporation and the |
| equally owned by two shareholder-employees, Smith | | | | other is a C corporation. The S corporation can |
| and Jones. Smith and Jones each get a $10,000 | | | | distribute the entire $100,000 in profits to DaVinci as |
| business deduction on their individual tax returns | | | | dividends because there is no corporate income tax. |
| because of the S corporation loss. This $10,000 | | | | DaVinci then pays $35,000 in personal income taxes |
| deduction might save them each as much as $4,000 in | | | | on the S corporation profits, which means she nets |
| federal and state income taxes.A second, big S | | | | $65,000 in after-tax profits from the S corporation. In |
| corporation benefit: As compared to almost every | | | | comparison, the C corporation can't pay the entire |
| other business form, S corporations can save their | | | | $100,000 in profits to DaVinci. The C corporation first |
| owners self-employment or Social Security/Medicare | | | | pays $22,250 in corporate income taxes. When the C |
| taxes. Suppose, for example, that Adams, Brown and | | | | corporation pays the remaining $77,750 to DaVinci as |
| Cole independently each own businesses that make | | | | a dividend, DaVinci pays another $11,663 in 15% |
| $90,000 a year in profits. Each business owner may | | | | "dividend" taxes on the C corporation profits. This |
| pay $13,000 in income taxes. But, unfortunately, that's | | | | means that DaVinci nets roughly $66,000 in after-tax |
| not the only tax they pay. Each owner also pays | | | | profits from the C corporation profits. In this case, |
| self-employment or Social Security/Medicare taxes.For | | | | DaVinci saves money with a C corporation in spite of |
| example, Adams operates his business as an LLC and | | | | having to pay the corporate income tax.How to Get S |
| therefore pays 15.3%, or roughly $13,500, in | | | | Corporation BenefitsTo create an S corporation and |
| self-employment taxes on his profits.Brown operates | | | | receive S corporation tax savings, you need to do two |
| his business as a C corporation which pays all of its | | | | things: First, you must incorporate the business either |
| profits to him as a salary. Accordingly, Brown (through | | | | as a regular corporation or as a limited liability |
| his corporation) also pays 15.3%, or roughly $13,500, in | | | | company. Second, you need to make an election with |
| Social Security and Medicare taxes.Cole's situation is | | | | the IRS to have the corporation or LLC treated as an |
| different. Cole operates his business as an S | | | | S corporation. The S election is made with form 2553, |
| corporation which means that Cole can split his | | | | available from the web site. Note that some states |
| $90,000 of profits into two payment amounts: salary | | | | (such as New York) require a separate state S |
| and S corporation distributions. Suppose that Cole says | | | | election.A final tip: S corporations can save you |
| only $40,000 of his profits are salary and takes the | | | | thousands of dollars annually, but your tax savings |
| other $50,000 as a "dividend" distrbution. In this case, | | | | can't start until you elect S corporation status. If you're |
| Carter pays the 15.3% Social Security/Medicare tax | | | | interested is electing S status to save on taxes for |
| only on the $40,000 in salary. Carter therefore pays | | | | next year, you may want to call your tax advisor or |
| roughly $6,000 in Social Security/Medicare taxes-and | | | | attorney right now!Redmond WA CPA Stephen L. |
| annually saves $7,000 in taxes as compared to | | | | Nelson is the author of QuickBooks for Dummies and |
| Adams or Brown.S corporations also, sometimes, | | | | more than 100 other books as well. |