This is a special tax structure that is created by Subchapter-S of the Internal Revenue Code which allows pass through taxation. All profits and losses will pass through the corporation to the owners. The owners will pay tax on the profits on their tax return. With a S-Corporation, the profits will only be taxed once.
In order to be taxed as an S-Corporation, you must meet the all of the following (this is not intended to be a complete list – laws are subject to change):
A S-Corporation can also save you money from self-employment taxes. Self-employment tax is a social security and medicare tax of 15.3% (subject to change) that is levied against income that is derived from business activities. As long as the S-Corporation pays a reasonable salary/wage to the owners who work for the company, any excess profits distributed to the owners at the tax year end will NOT be subject to the self employment tax.
Most small businesses that form a corporation will choose a S-Corporation tax structure because of its tax savings. In order to become a S-Corporation, form 2553 must be filed with the IRS. If this form is not filed on time, then the corporation will automatically be treated as a C-Corporation and is subject to double taxation. If you are selecting the S-Corporation tax structure, please be sure to add the preparation service for IRS Form 2553 S-Corporation election at the end of the questionnaire.
Special Note: If more than 25% of the company’s gross profits are derived from “passive investment income” (i.e. rental income, royalties, dividends, interest and annuities) over 3 consecutive years, the S-Corporation status may be revoked and the company will revert back to its default tax structure. Additionally, the excess passive investment income will automatically be subject to the highest corporate tax of 35%. If you are in a business which primarily collects passive investment income, the S-Corporation is not an ideal tax structure and you should consider the C-Corporation or forming an LLC instead. Most companies that primarily derive investment income will typically form an LLC because of its tax flexibility.