Why is an S-Corporation the Best Option for You?

Natalya Itu

February 23, 2016

Why is an S-Corporation the Best Option for You?

Many business owners are confused about the difference between “LLC” and “LLC taxed as an S-corporation.” When you create a business and are not sure how fast it will grow or when it will become profitable, the best way to start running your business would be by opening an LLC. A Limited Liability Company is taxed and reports its business activities on the tax return in the same manner as a sole-proprietor would report their business activities. The difference is the legal protection (which is not my expertise to discuss) as well as ability to convert your LLC into an S-corporation retroactively, if or when needed. Now, the question arises: Why would I want to run my business as an S-corporation?

There are three good reasons, in my opinion, why you would want to operate your business as an S-corporation. First, you save money on payroll taxes (FICA taxes). Net income from S-corporation is not subject to the self-employment 15.3% tax. However, keep in mind that a reasonable salary is a must if your business makes money and if you take shareholders’ distributions. Failure to run an official payroll can cause an IRS audit and reclassification of your shareholders’ distribution into salary; thus subjecting you to the 15.3% tax plus penalty and interest. Therefore, consulting a CPA is a very important step in this matter since he or she can determine how much your reasonable salary should be. Tax savings can be significant; sometimes several thousand dollars, depending on your net income. Also, earnings from an S-corporation (net income) is not subject to additional Medicare Tax.

The second reason to run your business via S-corporation status is a much lower risk for an IRS audit. We, CPAs, think the risk of being audited when you operate your business as an S-corporation or Partnership (every business entity except Schedule C) is much lower, almost 10 times lower. It seems like the IRS focuses on Schedule C audits much more often. The reason can be very simple, usually Schedule C filers prepare their own tax returns, thus the occurrence of overestimating deductions and even underestimating income is much higher. Also, if tax payers show up for an audit without Enrolled agents, CPA or Tax Attorneys (most of the time they would not hire professionals to “save money”), they will be more inclined to sign a tax deficiency agreement with the IRS and establish payment plans. Thus, for the IRS, it is a higher probability of collecting more money from these taxpayers. For the IRS your audit is a business decision, they need to consider the chances they will prevail and how much they could collect from you in additional taxes.

The third reason for being an S-Corporation is the S-corporation, like an LLC, is a pass thought entity. Unlike C-corporation, its losses carry over to the shareholders personal tax return and can off-set against his or her other income reported on Individual tax form 1040. However, you need to pay attention to your financial interest in your S-corporation, which is called Basis, because you can take losses from the S-corporation only against your basis in the corporation.

The IRS allows a late S-election if needed for your business effective January 1st, 2015. By filing a form 2553 and writing “filing pursuant Rev Proc 2013-30” and having a reasonable cause for not filing S-election on time, you have a very good chance to be classified as an S-corporation effective beginning of last year. Please keep in mind, S-corporation tax returns are due by March 15th unless six months extension is filed. Therefore, if you need to apply for a later S-election or timely 2016 S-election, form 2553 filing deadline is March 15th, 2016.

Operating your business as an S-corporation, might be a good idea or may not be. Each business and personal situation is unique, and therefore, consulting with a CPA is a very good idea. Please feel free to contact our firm if you have any questions regarding S-corporations.

February 22nd 2016
Colorado Business CPA

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