What the Heck is an S Corporation?

Business owners may have heard the term “S Corporation” or may even be an S Corporation, but do not really understand what it means and how it affects their business. A corporation or an LLC can elect to be treated as an S Corporation for federal tax purposes, and doing so can potentially save the business and its owners significant amounts of money in federal taxes.

If a corporation does not elect to be treated as an S Corporation, it will default to be taxed as a C Corporation. C Corporations experience “double taxation” and the income to the corporation is taxed twice. Electing to be treated as an S Corporation, however, causes the income and losses to the corporation to be passed to the shareholders and taxed only once. Similarly, if an LLC does not elect to be taxed as an S Corporation, it will default to being taxed as a disregarded entity, and all of the income to the LLC will be taxed at the business owner’s (or owners’) personal tax rate including self-employment tax. If you’re already in the top tax bracket, that means you could be inching near a 50% tax rate. That’s a lot! Electing to have the LLC taxed as an S Corporation, however, allows the owners to take a reasonable wage from the LLC as if they were employees and avoid having that self-employment tax on 100% of the income, because the income in excess of the “reasonable wages” will be taxed as dividends (which is much lower than the highest income tax bracket), thus avoiding the self-employment tax altogether. But not all businesses can elect to be taxed as an S Corporation. The IRS has set some requirements for businesses that want to be taxed as an S Corporation. That’s why huge publicly-traded companies, for example, aren’t typically taxed as an S Corporation; they don’t meet the IRS’s eligibility requirements. But luckily for you (and for me), most small businesses will be eligible for S Corporation tax treatment.

Denver, Colorado business attorney Aiden Durham can help you decide if your business should be taxed as an S Corporation. Contact Aiden at (720) 379-3425 or [email protected].