Did you know that the designation you give your business can impact how much you pay in taxes? Registering a business as an S corporation is one way that many business owners have found to significantly reduce the amount they pay in taxes each year. Keep reading to learn more about how this business designation can save you money.
We work with a variety of small-business owners, and their businesses can have a variety of designations. From sole proprietorships to partnerships, LLCs, and more, we help these businesses’ owners and partners save on their tax returns every year. But did you know that the designation you give your business can impact how much you pay in taxes? Registering a business as an S corporation is one way that many business owners have found to significantly reduce the amount they pay in taxes each year. Keep reading to learn more about how this business designation can save you money.
A Look at Pass-Through Entities
Before we get into the specifics of S corporations, let’s talk about the broader designation that many small businesses operate under—pass-through entities. A pass-through entity is a business or organization that is not subject to corporate income tax (unlike C corporations, which are taxed as a separate entity). Pass-through entities allow the income, losses, and deductions to be passed down to the owners and partners in the business; those numbers are then reported on their individual tax returns, and the partners themselves are taxed at their regular income levels.
Registering as any type of pass-through entity allows a business to avoid the double taxation that C corporations are subject to. For a C corporation, income is taxed when the business receives it, and the partners are taxed when they receive the income from the business. Since S corporations are a pass-through entity, this is just one way that this business designation can save you money in taxes. Other pass-through designations include partnerships, limited liability companies (LLCs), and sole proprietorships.
Saving More than Other Pass-Through Entities
But how do S corporations differ from other pass-through entities? And how can this specific designation save you even more than the other types listed above? The difference lies in how you, as an owner or partner, are paid from the business.
With other pass-through entities, the business’s net income is typically distributed among all owners or partners equally. So, your income varies based on the company’s profits. When receiving business income in this way, the money you receive is not only subject to your standard tax rate; you must also pay self-employment taxes on the income. For 2020, that’s an additional 15.3% tax on all of your business income.
But S corporations pay their partners differently. Rather than receiving a share of the profits, partners in an S corporation pay themselves an “officer’s wage.” You can set your wage at the beginning of each year, and like any other employee in your business, will receive a regular paycheck as well as a W-2 when tax season begins. Because you are now a W-2 employee, you no longer have to pay the 15.3% self-employment tax on your income. You can imagine how much this will save you each and every year.
Do You Qualify for This Designation?
Of course, not every business will qualify to register as an S corp. To be eligible to receive this designation, your company must be a domestic corporation with only one class of stock. You can have no more than 100 shareholders in your business, and those shareholders must be US citizens or residents. (Certain estates, trusts, and tax-exempt organizations also qualify as allowable shareholders.) If you meet these requirements, it may be worth exploring whether or not this business designation is right for your company.
It’s important to note that, even if you qualify to register as an S corporation, that doesn’t necessarily mean that it’s the best choice for you. If you’re considering changing your company’s business designation, we strongly recommend that you sit down with a business tax expert to discuss all of the pros and cons of this decision.
As experienced professionals in the world of business finances, the accountants at Kohl & Company CPAs can help you to decide what the best designation is for your business. We can also assist you with filing your business’s corporate tax return, as well as helping you to accurately report your business income on your personal return. Give us a call to set up a consultation with a CPA today.