Choosing the proper entity for your business
(Part 3 of 5)
S CORPORATION is a corporation that has elected to be taxed under Subchapter S of the Internal Revenue Code. This type of entity enjoys both the limited liability of corporations and absence of double taxation of sole proprietorships and partnerships. The corporation elects to be pay zero corporate federal tax and to pay a super-low California franchise tax of only 1 ½ precent. S corporations enjoy the best of both worlds of sole proprietorships and corporations.
A. Advantages:
1. Single tax – The entity escapes taxation at the corporate level. There is only a one-time tax at the shareholder level. The net income is passed through a K-1 to the shareholder.
2. Corporate net losses – are also passed through and taken advantage by the shareholder to offset other income. For example, a shareholder’s loss of $20,000 can offset the spouse’ $30,000 wage leaving the couple with zero taxable income after deducting standard deduction and personal exemptions. Nice.
3. Limited liability – is enjoyed since it is a corporation, a separate entity.
4. Self-employment tax – does not apply to the net income of S corporations. This savings can be substantial, as the shareholder does not have to pay FICA of about 15 precent on the net income passed through from the corporation. This savings in the first year alone can pay for incorporating costs.
5. Accumulated earnings tax – does not apply to S corporations.
6. Personal holdings tax – does not apply to S corporations.
7. Alternative minimum tax – also does not apply to S corporations.
8. Trust Fund – Discuss with your tax adviser how you can save on the employer’s portion of problematic delinquent payroll taxes.
9. Passive losses – of passive S corporation shareholders can be offset against passive loss activities with their S corporate earnings.
10. Deductible business interest – S corporate shareholders who incurred debt to acquire company stock may deduct the expense as business interest if they materially participate (debts of sole proprietors are treated as investment interest that can only be offset against investment income).
B. Disadvantages:
1. Some fringe benefits received by 2 precent shareholders are not excludable from shareholder income. These include $50,000 group term insurance, health insurance premiums, meals and lodging for the convenience of the employer, and the $5000 death benefit exclusion.
2. Calendar year – must be used generally.
3. Pension plan borrowings – prohibited for 5 precent shareholders.
4. New shareholders may miss to file S election documents or existing dissident shareholders may purposely cause trouble by making a disqualified transfer of stock..
5. Higher marginal tax – than a C corporation could result.
6. Limitation on the use of cash basis – an S corporation that has more than 35 precent of its losses allocated to shareholders who do not actively participate in the management of the company will be treated as a tax shelter and therefore will be required to use the accrual method of accounting.
7. Tax liabilities of an S corporation in trouble could end up with the shareholders (as opposed to being trapped inside a C corporation). You could enjoy the tax benefits of an S corp and switch to C corp as soon as problems are anticipated.
* * *
Sy Al-os Accountancy Corporation provides accounting and tax services to individuals, corporations, LLCs and business entities. The Firm has a niche in defending taxpayers audited by the IRS and other governmental agencies. The firm celebrates its 38th anniversary in 2015.
* * *
Victor Santos Sy graduated Cum Laude from UE with a BBA and from Indiana State University with an MBA. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation in 704 Mira Monte Place, Pasadena, CA 91101. He has 50 years of experience in accounting, consulting, and tax work.
* * *
The Firm proudly welcomes Arlene Al-os in 2015. She obtained her bachelors of Science in Accountancy from Mindanao State University and MBA from Ateneo de Manila University. She teaches intermediate accounting at UCLA and was a professor of Economics at Asia Pacific College. She has over 15 years of experience including member firms of KPMG and BDO Seidman accounting firms.
* * *
Our readers may call (626) 744-0200 or email tax questions to [email protected]. Please visit our website for about 300 tax tips at www.victorsycpa.com.
