How Are S Corporations Taxed? Here’s A Quick FAQ
It’s no secret that starting an LLC or corporation requires business owners to be equipped with thorough knowledge. However, understanding the taxation laws in your state can be some of the most complex information to absorb, especially when you consider the fact that forming an LLC and forming a corporation constitute very different tax laws. Here’s a quick FAQ to help you understand the tax implications that come with forming an S corporation.
What is excess net passive income?
If you’re learning how to form a corporation, you’ll have to be able to determine which types of income are considered excess net passive income. Excess net passive income is earned by an S corporation and includes any income from interest, annuities, dividends, rents, and royalties. Keep in mind that if your business’ excess net passive income makes up more than 25% of its gross receipts, the excess net income tax will take effect. Fortunately, the IRS has provided a usefulworksheet for S corporation owners to calculate their excess net passive income.
Are S corporation shareholders required to pay a self-employment tax on their portion of the corporation’s profits?
Unlike other business types, shareholders of S corporations are not required to pay self-employment taxes on their share of the business’ profits.
There is a catch, though: obliviousinvestor.com explains, “before there can be any profits, each owner who also works as an employee must be paid a “reasonable” amount of compensation (e.g., salary). This salary will of course be subject to Social Security and Medicare taxes to be paid half by the employee and half by the corporation.”
Keeping this information in mind, the savings that result from lack of self-employment taxes only generate when the S corporation earns enough of a profit to pay out after paying the required “reasonable compensation.”
What are the deadline restrictions regarding S corporation election?
In order for the election to be effective as of the beginning of that tax year, election must be filed on or before the 15th day of the third month of the corporation’s tax year. You should also keep in mind that a corporation may re-elect S corporation status only on the fifth year after the year in which the termination or revocation became effective.
Ultimately, understanding the tax laws that come with starting an LLC or corporation can help you make the best financial decisions for your business. For more information about corporation and LLC advantages, contact MyUSACorporation.