The honest truth is that for most small businesses, an s-corporation is going to be the best tax entity choice due to its flexibility and advantageous rules.
In an earlier blog, we briefly mentioned s-corporations how they related to LLC’s. Today, we’re going to specifically focus on s-corporations and how they distinguish themselves from other tax entities. The honest truth is that for most small businesses, an s-corporation is going to be the best tax entity choice due to its flexibility and advantageous rules.
When a corporation or LLC first identifies itself with the IRS, an s-corporation cannot automatically be designated to the business. In order to receive s-corporation status, a company must first elect s-corp status by filing Form 2553 with the IRS. The Form 2553 does not have to be filed immediately when the FEIN is obtained, so long as it is filed 75 days after initially obtaining the FEIN, it should be automatically accepted.
But what if 75 days have passed? Luckily for small businesses, the IRS recognizes that sometimes, it happens. So long as the owners can swear that the company was treated as an s-corporation for the entirety of its existence, the s-corporation election should be accepted by the IRS.
One of the most attractive items to an s-corporation is the flexibility that it provides owners.
In a way, s-corporations are similar to partnerships. The shareholders receive a K-1 to illustrate their gain for the year in proportion to their ownership interests. Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally taxes are not paid at the corporate level. However, the s-corporation must file a Form 1120S return with the IRS.
One of the most attractive items to an s-corporation is the flexibility that it provides owners. They do make tax-free non-dividend distributions unless the distribution exceeds the shareholder's stock basis. If this happens, the excess amount of the distribution is taxable as a long-term capital gain. What does this even mean? In more simple terms, business owners can often take their distributions from the business tax-free so long as certain requirements are met. The largest requirement to keep in mind is that the business owner must pay themselves a reasonable amount in the form of a salary and the appropriate taxes must be paid on that salary.
S-corporations are often the recommended taxation entity for most small businesses. In other circumstances, it may be more advantageous to serve as a c-corporation (if the owner has a high tax bracket) or possibly even a partnership/sole proprietorship. Regardless of the best option for you, the professionals at Hampleman Law have the knowledge to help you make educated decisions. Contact us for an initial, no-cost consultation today!
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