Small and mid-sized business tax preparation can be complicated, especially for those who have opted to run their business as an S Corp. Though converting to an S Corpenables businesses to save more money through taxation than a sole proprietorship, the IRS regulations around it are what makes it complex to navigate.
A benefit of an S Corp is the distributions you receive as an owner do not have payroll taxes withheld. However, the IRS requires the owner to become an employee for tax purposes, and, on top of that, take a “reasonable salary”. Over or underpaying yourself, or misrepresenting a salary as distributions, could result in costly penalties.
What is an S-Corp?
An S Corporation, often referred to as an S-Corp, is a specific type of business structure in the United States that combines elements of both a traditional corporation (C-Corp) and a partnership or sole proprietorship. S-Corps are a popular choice among small to mid-sized businesses because they offer certain tax advantages and liability protection for their owners.
Here are some key characteristics and features of an S-Corporation:
Taxation
One of the primary benefits of an S-Corp is its pass-through taxation. This means that the company itself does not pay federal income taxes. Instead, the profits and losses “pass through” to the individual shareholders, who report their share of the income on their personal tax returns. This avoids the issue of double taxation that is associated with C-Corporations.
Limited Liability
Shareholders of an S-Corp enjoy limited liability, which means that their personal assets are generally protected from the company’s debts and liabilities. However, this protection is not absolute, and there are exceptions, such as in cases of fraud or personal guarantees.
Ownership
S-Corps can have up to 100 shareholders, and these shareholders must be U.S. citizens or residents. Additionally, S-Corps cannot be owned by other business entities like C-Corps, LLCs, or other S-Corps.
Management
S-Corps typically have a board of directors, officers, and shareholders. The management structure can vary, and it is often determined by the company’s bylaws.
Formalities
Like C-Corps, S-Corps are required to adhere to various corporate formalities, such as holding regular meetings, keeping accurate records, and filing annual reports with the state.
Stock Classes
S-Corps can have only one class of stock, which means that all shareholders have the same rights in terms of profit distribution and voting.
Capital Raising
While S-Corps can issue stock to raise capital, they may have limited flexibility compared to C-Corps when it comes to attracting investors.
Termination
The S-Corp election can be terminated if certain conditions are not met, such as exceeding the allowable number of shareholders or having ineligible shareholders.
Research Your Competition
To first get an idea of what to pay yourself, you need to look into what others get paid for the same services you provide. For example, if you freelance as a social media manager, you would want to find out what the usual salary is for a social media manager who is an employee of a company. In general, you want to pay yourself the same amount of money you would earn if performing the same services for another business of a similar size.
List The Services You Provide
To determine your salary, you also need to have a firm idea of the services you provide the business. As an owner of a small business, this list might be pretty extensive. For instance, training, marketing, sales, and production might all be your responsibilities.
In this scenario, combine all of the rates typically paid for those services to determine your salary. We suggest adjusting your salary if your business makes less than your competitors or you only work at this business part-time.
Consider All Factors
Just like many factors would be taken into account when determining an employee’s salary, you need to consider the components that generally affect employee compensation. Your experience, for example, might impact your salary, as well as the time and effort you put into the business. Payment to other employees will also affect how much you pay yourself.
As you go through the process of determining a salary and taking all factors into account, be sure to document how you landed on that specific salary. That way, if the IRS performs an audit, you will have the reasoning for your salary readily available.
Contact a Local CPA Firm
Small business owners tend to have a lot on their plate, and adding the complexities of operating as an S Corp can bring may seem daunting. In that instance, it may be worth the investment to outsource to a small business tax accountant who is familiar with all IRS regulations. Reaching out to Scharf Pera & Co., PLLC, a local small business CPA in Charlotte, allows you to focus on what you do best–running your business.