7 minute read
Selecting the right type of entity for a business is one of the most important—and, without the right assistance, stressful—decisions an owner can make. Choosing to organize a business as an S Corporation (“S Corp”) can provide several benefits depending on the organization’s structure, activities, and tax planning goals.
Before answering how S Corps are taxed, it is important to have a basic understanding of what an S Corp is and how it is formed and understand the distinct advantages and disadvantages that this entity structure can provide. An S Corp is a type of pass-through entity where the corporation chooses to have its income taxed through its shareholders rather than through the corporation itself. S Corps also benefit from limited liability. S Corps are governed by Subchapter S of the Internal Revenue Code (“IRC”).
Not all entities can elect to be an S Corp. The S Corp election is limited to “Small Business Corporations” that meet certain requirements. Below are some common conditions and limitations for S Corps:
Notably, the IRC includes a list of specific “ineligible corporations” that cannot elect to be an S Corp, regardless of whether they meet the other requirements and thresholds.
As noted above, S Corps are pass-through entities. S Corps are not taxed at the S Corporation level. In other words, there is no corporate tax rate applicable to an S Corp. Rather, the corporation’s income, losses, deductions, and/or credits pass through to its shareholders. The shareholders of the S Corp must report on their personal tax returns the appropriate amounts based on the S Corps financials for the taxable year.
The S Corp will generally calculate its taxable income the same way an individual taxpayer does, with some exceptions. Each shareholder will be required to report each item from the S Corps’ financials for the year—the income, losses, deductions, and/or credits, along with any other nonseparately computed items—based on a pro-rata share allocation.
Additionally, capital gains and losses are passed through to shareholders from the S Corp level.
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To be considered an S Corporation, the corporation must properly file the appropriate election. An S Corporation election is made on Form 2553. The election must be filed no more than two months and 15 days after the beginning of the tax year that the S Corp election is to take effect—but the election can also be made at any time during the preceding tax year.
Corporations that have elected to be registered as an S Corp must file an annual Form 1120-S. Form 1120-S reports the S Corps’ income, gains, losses, deductions, credits, and other information for the year. Form 1120-S must be filed by the 15th day of the third month after the end of the S Corps’ tax year.
For example, a S Corp following a calendar year will be required to file Form 1120-S by March 15th. If the S Corp needs an extension to file the 1120-S and other applicable forms, it may file Form 7004 to apply for an automatic 6-month extension.
In addition to Form 1120-S, the S Corp must issue each shareholder a Schedule K-1 corresponding to the 1120-S. The Schedule K-1 will detail the specific shareholder’s share of the S Corps’ income, deductions, credits, and other items. The corporation will file all copies of the Schedule K-1s with the IRS as part of Form 1120-S. In certain circumstances, the individual shareholder may be required to include the Schedule K-1 as part of their individual tax return.
Depending on each S Corps’ specific circumstances, there may be other forms that the S Corp must file as part of its federal tax return. S Corps and its shareholders will want to consult with their tax advisers to confirm they comply with all federal filing requirements and deadlines.
Choosing the entity for a business should not be rushed. Business owners will want to take a hard look at the numbers and compare different entities to decide which entity type is best for the business.
Tax planning software like Corvee can make this decision straightforward and provide you peace of mind. Corvee tax planning software considers each entity type and 1,600 other tax-saving strategies to help you optimize your tax scenario, even if you own multiple businesses. The S Corp structure may offer tax benefits for many business owners. Learn more about how you can optimize your or your client’s tax position by signing up for a demo today!
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