Choosing the right legal structure for your business is one of the most important decisions that you will make as a business owner and will affect your terms of operation, your management structure, and raise legal and tax issues. Charlotte accountants are familiar with the advantages and disadvantages of sole proprietorships, partnerships, S-corporations, and other business structures. They can help you determine which one is best for your enterprise.
What Is an S-Corporation?
One popular business structure is the S-corporation. This structure combines some of the best features of a corporation, such as limited liability and a life span that is not dependent on whether a particular individual exits or stays with the business, while remaining a pass-through entity for federal tax purposes.
How Are S-Corporations Taxed?
The primary drawback of creating a corporation is the issue of double taxation. With most types of corporations, the business itself pays taxes on its earnings. The profits are also taxed at the individual level when they are paid to the shareholders in the form of dividends. Since S-corporations are pass-through entities similar to a partnership or limited liability company, the tax on the business’s profits are passed along to the individual owner/shareholders. Of course, S-corporations must still pay the same taxes required of any other business, such as employment taxes, state taxes, and property taxes.
How Are S-Corporation Shareholders and Shareholder/Employees Taxed?
S-corporations are required to file a Form 1120-S and a Schedule K-1, which outline the profits and losses for each shareholder. Shareholders must then report this information on their Form 1040. In general, owners of S-corporations are not considered self-employed, so there is no self-employment tax on distributions. If a shareholder also works as an employee of the business, they must receive “reasonable” compensation, and the average Social Security and Medicare taxes are withheld from the salary. This can create a sticky situation since some shareholder/employees may be tempted to circumvent employment taxes by paying themselves an extremely low “salary” so that they can take a higher distribution from the profits. In deciding if a salary is reasonable, the IRS and most courts typically look at the following:
- the duties and responsibilities of the individual,
- the training and experience level of the individual,
- the amount of time and effort that the individual devotes to the business,
- the salaries paid to non-shareholder employees,
- the average salaries in similar businesses, and
- the amount of the dividend paid in relation to the salary.
As one of the leading CPA firms in Charlotte, NC, Scott Boyar, CPA, provides accounting, bookkeeping, and tax support for businesses of all types and sizes. Contact us today for more information on our services or to schedule a consultation.