Small business owners know that every penny counts. Like the good farmer, you want to know that at the end of the season, you have reaped a good harvest. How do you know if switching to an S corporation status will yield significant benefits at the end of the tax year?
Think about this: You can be “double taxed” if you are now operating as a C corporation. Your profits, like the good harvest, can shrink since those profits are taxed to the corporation and taxed again to the shareholders when paid out as dividends.
As an S corporation, you can generally avoid giving away so much of what you have made. The profits and losses of your business are passed directly through to the shareholders and there is no Federal income tax. In California there is a minimum state corporate tax of $800 and maximum tax rate on 1.5 percent of profits. The S Corporation avoids the C Corporation double tax and allows shareholders to deduct corporate losses on their individual returns. This is especially advantageous to the new business owner, since losses are common in the first few years of operation. Capital gains and losses also pass through directly to shareholders and are eligible for the more favorable tax treatment of capital gain rates for individuals. Losses are deductible subject to limitations on shareholders returns.
Corporations that are good candidates for the S election are those that distribute most or all of its profits to shareholders, new businesses expecting net operating losses, corporations that must convert from the cash to accrual method, thereby increasing income to the corporation and corporations subject to the alternative minimum tax.
S Corporations also avoid the higher taxes associated with Personal Holding Companies which are assessed an additional flat 15 percent for Federal tax purposes and Personal Service Corporations which can be taxed at a flat 35 percent for Federal tax purposes. The profits are not subject to self-employment tax of 15.3 percent as are sole proprietorships and partnerships.
To schedule an appointment for additional information, please contact Theresa M. Stewart, CPA at 661-775-9534.