Question: Can doing business as an S corporation reduce the tax burden on the company as opposed to perhaps another entity such as a partnership or LLC?
Answer: One primary difference between an S corporation and a partnership is the employment status of owners who work in the business. In general, the owner of a limited liability company (or “LLC”) is not an employee of the LLC for tax purposes.
By contrast, an S corporation owner who performs more than minor services for the corporation will be its employee for tax purposes, as well as an owner. It is common for an active owner in an S corporation to wear at least two hats: As a shareholder (owner) of the entity and as an employee of the entity.
S corporation profit is not subject to self-employment tax. It is for this reason that many taxpayers favor doing business as an S corporation. This is because an owner does not have to pay employment tax on distributions (dividends) from the S corporation—that is, on earnings and profits that pass through the corporation to them as an owner. Thus, the larger the distribution of profit, the less employment tax required to be paid. Thus the reason why many smaller business elect “S” status for tax purposes.
However, the compensation the owner receives through salary is subject to FICA taxes.
The IRS can question owners who receive large cash distributions from an S corporation, arguing that the distributions were essentially disguised compensation in order to get around paying FICA taxes.
The IRS will frequently win those cases and in many cases, may collect penalties.
As always, if you have any questions or would like to learn more, please contact me at firstname.lastname@example.org or 301-575-0313.
ABOUT STEVE SHANE
Steve Shane provides strategic counseling to clients in need of estate administration, charitable giving and business continuity planning while minimizing estate, gift, and generation-skipping transfer tax exposure. He offers legal guidance to clients on asset protection and the proper disposition of assets in accordance with the client’s objectives, while employing tax planning techniques such as the use of irrevocable trusts, life insurance planning, lifetime gifts and charitable trust. He is also experienced with drafting documents for business planning, the incorporation and application for exemption for Private Foundations and the administration of decedents’ estates.
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