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With the new 21% flat income tax rate that applies to C corporations, it may not be as useful to use an S corp business structure as it once was. There are certainly advantages, including limited liability for owners, and no double taxation at the federal level; but, the S corp business structure may have lost advantage for your company.
Pros and cons
One of the main advantages of electing S status is the ability to pass corporate income, losses, deductions, and credits through to shareholders. This allows S corps to generally bypass double taxation of corporate income (once at the corporate level and again when distributed to the shareholder). Shareholders pay tax on S corp items on their personal returns and pay at individual income tax rates.
The new fixed C corp rate at 21% and the top rate on qualified dividends is 20% making double taxation less of a concern for many businesses. The top individual rate is 37%, meaning in some instances an S corp may not lead to better savings overall.
That being said, it is important to keep in mind that S corp owners may be able to take advantage of the new qualified business income (QBI) deduction, which can be equal to 20% of QBI.
State taxes may have a considerable impact as well. Determining what structure will be the most tax efficient for your business will require running the numbers with your tax advisor.
Not all businesses qualify for S corp status. To be eligible a business must:
- Be a domestic corporation and have only one class of stock
- Have no more than 100 shareholders
- Have only “allowable” shareholders, including individuals, certain trusts and estates. Shareholders can not include partnerships, corporations, and nonresident alien shareholders.
Some types of businesses, such as insurance companies, are not eligible.
Compensation paid to a shareholder should be comparable to what a non-owner would be paid for a similar position. The IRS is currently on the lookout for S corps that pay shareholder-employees an unreasonably low salary to avoid paying Social Security and Medicare taxes and then make distributions that aren’t subject to payroll. If a shareholder’s compensation does not reflect the fair market value of their services, the IRS may reclassify a portion of distributions as unpaid wages. The company will then owe payroll taxes, interest, and penalties on the reclassified wages.
S corp status is not one size fits all, but it may still be a good option for your business. This year’s tax law changes make weighing tax differences especially complex. We can help you to determine what business structure will benefit you the most. Contact us at 949-860-9902 or click here, and we will contact you.