Is an S-Corp Right for You? Business Structures and Tax Insights

Join Stephen Morris and Diana Tung from AdviseRE as they delve into the world of S-corps, a business structure coveted for its tax advantages. This video unpacks everything from the basics of forming an S-corp, including legal entities and IRS filings, to understanding its tax implications and compliance requirements. Whether you're considering converting your business into an S-corp or just curious about its benefits, this discussion provides essential insights into why S-corps are a popular choice for entrepreneurs aiming for tax efficiency and what income levels should consider this option. Tune in to discover how S-corp status could lead to substantial tax savings and learn the compliance hurdles that come with it.

Transcription:

So welcome everybody. We're back here together, AdviseRE here. I'm Stephen Morris.

• And I'm Diana Tung.

Today, we're going to be talking a bit about S-corps because I know this is a very exciting business form for all of you out there. I know you've heard about the tremendous tax benefits that you can get from it, but we're going to talk a little bit about what it takes to run an S-corp. What are the implications? What are the compliance considerations? And what are the tax benefits, and why do those tax benefits actually exist?

Okay Diana, so tell me, what are some of the ways we can get an S-corp started? What are the legal considerations? What type of entities are available to be an S-corp? And how do you even get that whole process started?

• Basically, an S-corp is truly a tax designation. When you think about a legal entity, you might think, okay, I'm going to incorporate a corporation or set up an LLC. Those are legal entities, right? But an S-corp is something that you elect to be with the IRS. You have to file form 2553 and basically tell the IRS, "Hey, even though I have this legal entity, like an LLC or a corporation, I want to be treated and taxed as a pass-through entity and an S-corp."

Give me some clarification on what types of entities are actually eligible for an S-corp. What is the difference between them, at least from a tax perspective?

• A corporation, typically from a tax perspective, is a separate legal entity. When you're thinking about the tax implications of a corporation, you're looking at double taxation. The corporation is its own separate entity, and then you own an entity, so there's a tax that applies to that corporation. Now, with an LLC, it gets a little funky because an LLC can be taxed as a corporation or as a pass-through entity. When you have this S-corp election, it's also taxed as a pass-through entity. It retains the corporate structure, but it’s taxed differently. There's no taxation at the entity level for federal purposes. Instead, all income, losses, or whatever happens in that business entity gets passed through to the shareholders of the S-corporation.

Great, so let's talk a bit about that. Why do we even file a tax return for an S-corp? If there's no tax due, as you're telling me right now, that S-corp's not paying taxes, then why do we even send something to the government and say, "Hey, you're ready to collect zero tax from us here?"

• I mean, why do you file a tax return for a partnership? There's no tax there either, right? There are a ton of tax forms out there that you have to file, even if they’re informational only. From the IRS's perspective, they need to know what's happening, what your income and expenses are, and all those details. Once it gets passed through to you, a K-1 is issued to you through that S-corporation.

Got it, okay, that makes perfect sense. Let's talk about the K-1 then. The income that flows from the S-corp to the individual—tell us about the character of that. Okay, the S-corporation makes a million bucks in a year, for example. What does that K-1 look like, and what are the tax implications of that K-1 to the individual shareholder?

• Typically, when you're receiving a K-1, this income comes through as ordinary income to the shareholder. It appears on your Schedule E, and any losses can potentially be taken against your W-2 income.

Okay, great. And that income surely has some sort of tax attribute that everyone loves about S-corps. What is that? What is so special about S-corp income that is very different from just the traditional Schedule C filer who's doing his or her own business tax returns?

• One of the biggest surprises for people starting their own side hustle is the self-employment tax. Typically, if you're employed, your employer pays half of that tax. But when you're your own employer, you pay the full self-employment tax. This can be a shock for those with a sole proprietorship, where business income is reported on Schedule C. With an S-corporation, you must pay yourself a reasonable wage. How you determine that varies based on your industry and work. Outside of that, income comes to you without the burden of self-employment tax. You're both the employer and employee in your own business, so for the reasonable wage you pay yourself, you're paying self-employment and payroll taxes. But everything else is just gravy on top.

Yeah, so when we're talking about self-employment taxes, to be clear, we're referring to Social Security and Medicare. Most people know that in a regular job, the employer pays half, and you pay half. But when you're self-employed, it can add up, especially at 15.3% of up to the first $168,000 in 2024. It’s a significant tax saving with an S-corp. But as you mentioned, paying yourself a payroll also brings additional compliance. Do you need to keep books and records, or can you just fill out a profit and loss on your Schedule C?

• We go through this all the time with clients, determining whether it makes sense to start an S-corp. There are costs, like maintaining books and records, and annual minutes for the corporation. You'll also have to run payroll and possibly file a tax return. These are added costs, so we often analyze at what threshold it makes sense to elect S-corp status.

What threshold do you typically see as a rule of thumb? Obviously, everyone’s situation is different, but around what income level, or net income level, in their business should people consider converting to an S-corp?

• Typically, once you're hitting about $75,000 to a six-figure mark, it's time to start looking at the numbers. In addition to payroll and bookkeeping, you’ll also have a tax return to file. These are definitely all things to consider.

You gotta pay us too, to do the work, just so you know. We'll be here for that. Okay, so thank you so much for all of that. This is the type of information we need to relay to you because when deciding on an S-corp, there are huge benefits, but also costs. We highly recommend it to clients, especially as you start getting past the $75,000 a year mark. You're on the path to significant tax savings.

So I hope today's discussion gives you some clarity and guidance on running an S-corp, the tax advantages, how to incorporate one, the required forms, and the associated costs, including payroll and bookkeeping. All these are important considerations as you decide whether to start your journey into the S-corp realm. Thank you for joining us, and we look forward to seeing you in our next video.