S Corporations have been making major headlines in the news. The Tax Cuts and Jobs Act (TCJA) is a new tax reform law that gives pass-through entities, like S Corps, a 20 percent deduction for qualified business income. The changes take effect in January 2018, so it will not affect tax returns filed for 2017.
Since pass-through entities are being significantly affected by the new tax law, many entrepreneurs are mulling over whether or not they should stay an S Corporation. Those that aren’t incorporated as an S Corp may also be considering if they should make the switch. While I cannot provide tax advice or tell anyone exactly what is best for their business, what I can do is outline more about what an S Corporation is and the benefits that the entity offers a business.
What’s an S corporation?
An S Corporation begins as a C Corporation or an LLC, which makes it a C Corp with an S Corp tax election. While the entity tends to operate in the same manner that a corporation would, their S Corp election essentially tells the federal government that it would like to be taxed as a partnership and not as a corporation. This helps small businesses to get around double taxation at the corporate level.
S Corps elect to have their profits, losses, deductions, and credits “pass-through” the entity level and only have them taxed at the shareholder level. Only the wages of an S Corp shareholder, who is an employee of the business, are subject to employment tax. As such, shareholders must be paid what is commonly referred to as “reasonable compensation” to avoid having the IRS reclassify their corporate earnings as wages.
Tax benefits aside, S Corps provide shareholders with protection for their personal assets and allow businesses to gain credibility. However, Read More Here