Tax Savings For Small Businesses 101, S Corporations

Save on taxes and you will be one step closer to relaxing on a beach.

The S Corporation came into existence in 1958 when Congress added Subchapter S to the Internal Revenue Code (IRC). One reason was to allow small business owners to avoid double taxation for C Corporations. The S Corporation has become a favored form of business entity for many small business owners because of this potential tax saving, as well as other potential tax benefits, such as the minimization of self-employment tax.

When you are self-employed you will owe 15.3% tax on your net earnings to pay Social Security and Medicaid taxes. The advantage of the S Corporation is that you are allowed to split your business income into two categories: (1) salary, and (2) distributions.

The salary portion of your income is a "reasonable" wage you pay yourself for services to the business. The 15.3% Social Security and Medicaid taxes will apply to the salary you pay yourself. As such, most business owners will want to minimize the amount of salary paid to themselves because it will minimize the amount of Social Security and Medicaid taxes that the business owner will pay.

The IRS requires you to pay yourself a "reasonable salary" for the services performed for the S-Corp. This is a legal term that means the salary should be comparable to what other businesses would pay for similar services in your industry and location. If the IRS determines your salary is unreasonably low, they can reclassify distributions as wages, potentially leading to back taxes, penalties, and interest.

The rest of the money that the business makes can be paid to the owner(s) as distributions and are not subject to the additional self-employment taxes like Social Security and Medicaid. The distributions are only subject to normal, ordinary income taxes.

In today's world, every penny saved counts, and the S Corporation is something most small business owners should consider as the preferred to operate their business. Of course, tax savings is only one consideration. As an attorney with significant experience working with sales of businesses, the S Corporation form can present complexities when it comes to transferring your business whether the reason for the transfer is estate planning, asset protection, or to sell your business for cash. A skilled attorney can advise you properly, and work through those complexities.

This is not legal advice and does not constitute an attorney-client relationship. If you would like to explore the possibility of receiving professional legal advice concerning the topic of this article or some other matter, please contact Swiderski Law.