S Corporations

Today TaxMama hears from Mary in the TaxQuips Forum. She says. “I was taking a real estate course and the instructor brought up the idea of having an s-corporation.  He said the IRS will allow you to set up an account as an s-corporation where you are allowed to take out a certain percentage of your earnings and only be taxed on the amount you take out.  Either 20% or 30%  I tried calling the IRS, but the person didn’t know what I was talking about!” 

Hi Mary,

 Your instructor was sort-of right about S Corporations.  But wasn’t really clear on the idea.

 S Corps were the favorite choice of savvy tax planners for many years.  Originally, you could have a business with high income in an S Corp.  You could take a small salary, with correspondingly small payroll taxes. That’s where your instructor used to be right.

Where he’s wrong is –  all the profits would be reported on your personal income tax return, as if this were a partnership. You would pay tax on all the profits.  Why was that a good idea? You would avoid the 15.3% self-employment taxes or Social Security/Medicare on those profits or a high payroll. That saved you several thousand dollars a year.

 The bad news is, IRS is auditing all those S Corporations with no shareholder wages or very low, unreasonable wages. So, that planning option is now closed.

 The other problem with S Corps is, it may not take deductions for normal employee benefits for anyone who owns more than 2% of the stock. Typically, S Corps are 100% owned by one or two people. So, that shuts the door on deductible benefits. As you can see, it’s not as useful an entity as it used to be.

 Mary, you’re wanting to make a long-term decision about how to form your business. You have lots of personal considerations, financial needs and goals that are unique from anyone else. That’s why good tax professionals spend 50+ hours taking classes and staying up to date each year. Please, invest in a two-hour consultation with a good tax pro who can help you choose the right business entity that is best for your life and your business.

And remember, you can find answers to all kinds of questions about s corporations and other tax issues, free. Where? Where else? At www.TaxMama.com.

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