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Guide to S Corporation Taxes: How to File & Benefits

There's a lot of misinformation doing the rounds when it comes to the S corp status and its deemed tax benefits. Read this guide to learn how S corps are taxed.

As an LLC or C corporation, you might be mulling over the choice to convert to an S corporation. This article will walk you through S corp tax filing and other authentic information before you make up your mind. Read on!

How Are S Corps Taxed?

S corporations are not taxed in the same way as other C corporations are. S corps are liable to file Form 1120-S, but it does not pay the taxes from its earnings.

Instead, S corporations enjoy the benefit of what is known as pass-through taxation. Here, the shareholders of the company, among which the company divides its income as dividends, pay taxes on the basis of the dividend they have received.

Should You Elect S Corp Status

Absolutely! By classifying your business as an S corporation, you stand to enjoy some tax perks. Let's look at some benefits of S corp taxation below:

1. Avoiding Double Taxation

Double taxation, as the term suggests, refers to the incidence where the income of a firm is taxed twice, under two different laws. In both cases, the nature of the income changes, which renders it taxable under a different law, even if it has been taxed earlier.

For instance, Firm X earns a taxable income of $50,000 and has two shareholders, Abel and Belinda.

  • The initial tax which will be paid is the corporate tax at the firm's level. So, Firm X will file a corporate income tax return, wherein it will pay 21% of its total taxable income as corporate federal tax. Firm X pays $10,500 as tax, leaving it with a net income of $39,500.
  • Let's say that this $39,500 is equally divided amongst Abel and Belinda. They receive $19,750 each.
  • This dividend that Abel and Belinda receive will be taxed as a short-term capital gain. The total tax they pay will include the amount taxable for this $19,750 dividend they received.

So, in effect, the total income of $50,000 that Firm X had recorded was taxed twice in the financial year, once as corporate income and the other time as individual federal income.

The law states that S corporations, by passing through their income as dividends to the shareholders, do not have to pay taxes. The tax is paid by individual shareholders in accordance with the rate that applies to them.

Consolidated shareholder information is shared by the S corporation to the IRS in Form 1120-S.

2. Limited Liability

S corporations enjoy the dual entity status. Essentially, they are viewed as S corporations for taxation purposes, which means they don't have to pay corporate tax. But for all other purposes, they are considered normal C corporations.

This extends its owners the benefit of limited liability under the LLC status, and the personal liability of owners does not exceed their investment in the company.

3. Shareholder-Employee Status

S corp owners are liable to pay self-employment taxes on their own income instead of the total income of the firm. Other income is distributed amongst shareholders, which absolves the firm of any self-employment tax under FICA.

So an owner who is also an employee of the firm only pays the self-employment tax on their own income.

For instance, Farookh, the owner of Firm X, is liable to pay self-employment tax only to the extent of the salary he draws. The other income that he receives as a dividend is not taxable under FICA.

Since only Farookh's income is liable to be taxed under FICA, he may plan not to pay himself and take in all of his shares to circumnavigate this tax liability. But as per the IRS, Farookh must be paid a reasonable salary, even if the term "reasonable" is open for interpretation.

Electing S Corp Tax Status

A firm must first be incorporated as an LLC or a C corporation and then transition into an S corp. This is because an S corp is only a tax status, not an entity status.

  • If a C corp firm wants to elect the S corp tax status, it must submit Form 2553 to the IRS. The form must be signed by all the shareholders of the firm.
  • Form 8832 must be submitted by an LLC hoping to transition into an S corporation for taxes.

How to File S Corp Taxes

After preparing the profit and loss statements and balance sheets, you'll need to fill out a few forms to file your S corp taxes.

Form W-2

Employees of the firm receive compensation, the record of which is issued as Form W-2. A W-2 form for an employee must state the compensation they've received and the amount that the employer withheld from FICA.

Form 1120-S

Form 1120-S is the main form that S corporations must submit. It summarizes their payments to shareholders.

Detailed instructions to fill this form out are given below. It is advised that inexperienced owners do not fill this form on their own since it can prove to be confusing.

Part 1

This part entails basic business information such as the date of incorporation, Employer Identification Number (EIN), and the date of S corporation status selection. Profit and loss information is also presented here.  

If you are the owner and fill the form out, you need to sign right next to the space given. If you outsource the task to a tax filing service, they must also sign the form.

Schedule B

This is the longer part of the form and requires S corp owners to fill out the particulars of the business. You will need to input the products and services your company offers, the business activity code, and the accounting practice your firm follows.

There will be some questions that pertain only to particular types of businesses, while questions regarding shareholders and business payments would also need to be answered.

Schedule K

This schedule summarizes the information about the shareholders in your S corporation, including their income, tax deductions, and tax credits within the financial year.

Schedule L

The filling out of Schedule L is contingent on the answers to questions 11a and 11b on Schedule B.

If you answered yes to both the questions, you could skip this section. A "No" in either of the questions would demand that Schedule L be filled.

Schedules M-1 and M-2

If your firm had to fill out the previous schedule, it would need to fill in Schedule M-1 as well. This section balances your company's income or loss as per the accounting book with the tax return.

Schedule M-2 reports the balancing profit or loss that your corporation has made after all deductions.

What Is the Deadline for S Corp Tax Filing?

The deadline for filing taxes as an S corporation is March 15, 2021. However, an extension can be requested by filling out IRS Form 7004. These forms can be mailed via paper or electronically.

In Closing

If you are still unsure about electing an S corp status, you can get advice from a bookkeeping service like Fincent. Our team can assess your company's financial health and offer viable options to help you decide the right business entity.

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