The S Corporation

1
The S Corporation

• How It All Works!

Presented By Mark Borel, CPA Mark Borel
Associates, Inc.
2
What is an S Corporation?

• The S corporation was formed by Congress, for use
  by small business owners, offering the best
  characteristics of both a C corporation and a
  partnership
• It has become the most popular business entity
  type in recent years
• Numerous studies indicate lower overall taxes are
  paid when an S corporation is utilized.

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Common Characteristicsof S and C Corps

• Same liability protection
• Separate legal entities
• The owners are shareholders
•  Long standing case law
•  Easy transfer of ownership
•  Broader range of deductible expenses

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Common Characteristicsof S Corps and Partnerships

• Neither entity pays tax on net income
• Both are flow through entities, so net income
  and loss is reported on the owners tax return
• Losses can be claimed up to the investment in the
  entity
• Losses can be claimed against ordinary income
• Different income types keep their character as
  they flow down to the owner (i.e., interest
  income, L/T capital gains, etc.)

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So How is an S Corporation Formed?

• C corporation is formed with the Secretary of
  State
• File an S election with the IRS (Form 2553)
• - Filing deadline is 75 days from the first day
  of the
• proposed S year
• - In recent years, the IRS has approved late
  filing of S
• elections, but no later than the extended due
  date of the
• tax return

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When Should an S Corporationbe Used?

• When owners plan to work for the company
• Well suited for a single owner, and when owners
  are family members, or when the shareholders
  happen to be a few friends or acquaintances,
  and/or
• When the company has no plans to attract
  investors by going public, and/or
• When gt10 owners plan to offer services such as
  consulting, accounting, engineering, law, etc. to
  the general public Used to avoid classification
  as a personal service corporation (PSC) and 35
  flat tax on net income, and
• When owners desire to remove most of the profits
  from the company

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But How Does an S Corp Work?

• The S corporation files a separate, annual tax
  return, but does not pay tax on reported net
  income (Form 1120S)
• Instead, tax on the allocable net income (or
  loss) of the company is paid at the shareholder
  level
• If a shareholder works for the company, IRS
  requires them to take a salary

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How an S Corp Works (cont.)

• A shareholder who is also an employee, reports
  two types of income on Form 1040
• - Salary income as an employee (Form W2)
• - Investment income as a shareholder (Form K1)
• Similar to Form W2, the company issues Form K1 to
  each shareholder for completion of their
  individual tax return
• There is no tax withholding on flow through
  income
• These two types of income are not taxed the same

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How an S Corp Works (cont.)
Flow through income reported on Form K1 is
subject to only federal income tax

• The tax rate that applies depends on the type of
  flow through income
• The most common type is classified as ordinary,
  meaning no special reduced tax rates apply, but
  losses can be applied against other income (up to
  your investment)
• FIT is assessed using the individuals graduated
  tax rate schedule at rates of 10-35, which is
  lower than C corp rates

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How an S Corp Works (cont.)
Employment related income reported on Form W2
is subject to both federal income tax and
employment taxes

• Employment taxes are paid by both the company and
  the shareholder
• Withholding rules apply to this type of income
• FIT is assessed using the individuals graduated
  tax rate schedule at rates of 10-35, which is
  lower than C corp rates
• Payroll expenses are deducted by the Company

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Getting The Money Out

• Because income is taxed at the individual level
  rather than the company level, money can later be
  removed as a distribution to the owner with no
  further tax consequences.
• A distribution is simply a check written to the
  owner with no withholding, and coded to the
  shareholders equity account.
• This procedural difference allows the owner of an
  S corporation to easily remove money, and manage
  (within reason) employment taxes paid on
  executive salaries.

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So How Much Salary Should I Take?

• The IRS advises paying yourself a reasonable
  salary for the services you provide similar to
  what you could earn elsewhere
• IRS guidance on this subject is minimal
• This allows for some leeway on setting executive
  salaries
• Paying no salary will greatly increase the odds
  of an audit occurrence, and an IRS levy of
  employment taxes, penalties and interest on all
  flow through income.

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S Corporation Tax Advantages

• No double taxation of distributions to
  shareholders
• Income automatically flows to the shareholder
  level where tax rates are lower than corporate
  rates
• Flow-through income is subject to ordinary
  income tax rates, but not employment taxes.
• Flow-through income retains its
  characteristics, possibly qualifying for special
  tax rates at the shareholder level, i.e., 15
  capital gain rate applied to long term capital
  gains
• Income of the company is easily distributed to
  shareholders

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S Corporation Disadvantages

• Special limitations may apply on deductibility of
  employee/fringe benefits for gt2 shareholders
• Nondisclosure (privacy) of shareholders cannot be
  achieved from the IRS
• Greater audit potential than C corporation due
  primarily to shareholders/employees not taking a
  salary

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Thank You For Attending!

• Call 888-243-6555 to receive your complimentary
  whitepaper outlining a side-
• by-side comparison of C Corporations vs. S
• Corporations

Presented by Mark Borel, CPA, President Mark
Borel Associates, Inc.