Business owners of corporations will by default have a “C” Corporation. If they are eligible and they elect, they could be a Subchapter S (“Sub S”) corporation.
An eligible Sub S corporation meets the following criteria:
* Domestic corporation
* No more than 100 shareholders
* The only shareholders are individuals, estates, certain exempt organizations and certain trusts
* There are no nonresident alien shareholders
* The company has only one class of stock
* The company is not an ineligible corporation
* The company will generally adopt a tax year ending December 31
* Each shareholder consents to the Sub S election
To elect Sub S status the Corporation would file Form 2553, Election by a Small Business.
Here are 3 reasons to elect Sub S Status:
1) No Double Taxation
While both a “C” Corporation and a Sub S are both separate legal entities, the “C” corporation is also a separate taxable entity. If a “C” Corporation has profits that are retained, it will pay income tax on these profits. If the profits are later paid out to the shareholders, the shareholders will be taxed. Hence the term, “double-taxation.”
With a Sub S, there is no double taxation. With a Sub S corporation all of the profits or losses are passed through to the shareholders any they pay the income tax.
2) Possible Minimization of Social Security Taxes
Wages are subject to Social Security tax. An employee pays 7.65% on the first $113,700 in 2013. The employer must match this amount and remit it. Earnings over this amount are subject to the Medicare tax of 1.45%. The employer must also match and remit this amount.
Profits from a Sub S are not subject to Social Security or Medicare taxes. Caution should be exercised here however. Shareholder / employees need to be paid reasonable compensation. The Internal Revenue Service (“IRS”) is looking closely at this issue.
3) Single Tax on Sale
This may be the most important reason of a rapidly growing company. When a business is sold, most buyers don’t want to buy the stock of the seller. This is due to potential liability issues. Most buyers want to buy the assets of the business and not take on any liability.
If it was an asset sale by a “C” Corporation, double taxation would rear its ugly head again. With an S Corp there is no double taxation (assuming you have been an S Corp for 10 years). Any gains on the asset sale will flow through to the shareholders.
Will you elect Subchapter S Tax Status?
We are not rendering legal advice. Consult your attorney for legal advice.
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