S Corps: the latest craze

There are lot of people out there on the internet talking about S Corps. Some of these people are outright lying, but there is some truth in what's being said. Let me sort out the actual benefits and downsides so you can confidently call BS when you hear it.

What is an S Corporation?

It's a tax only form of business, for starters. You can't go to your secretary of state and set up an S corporation; you either set up an LLC or a Corporation as the legal entity. Once you've done that, you apply to the IRS to allow it to file taxes as an S Corp.

So why do it?

The biggest advantage is that it allows you, the owner, to report the business income or loss on your personal tax return and therefore pay tax on it at your individual income tax rate, while also allowing you to take out the profits as a tax-free distribution. Compare that to a regular ("C") corporation, where profit distributions (aka dividends) are taxable income to the owners in addition to the corporation owing income tax, or a sole proprietorship (Schedule C), where you pay self-employment tax (15.3%!) plus income tax on every dollar of net income.

When you put it that way, it sounds like a great idea! So what's the catch?

The IRS is wise to the fact that you would rather skip paying any and all payroll taxes or self-employment tax, and instead take cash directly from the business. That's why you must pay yourself a "reasonable salary" for the services you perform for the company. The tricky part is that there is no formula for what a "reasonable salary" would be, so it's entirely up to you to determine what that amount is. It is also entirely up to the IRS' discretion to determine whether or not you are correct! Therein lies the rub; trying to save yourself some tax could lead to fines, penalties, and even criminal charges if your idea of "reasonable" is way too far off the mark.

There are more compliance tasks like filing the S Corp tax return, setting up payroll, completing annual registrations, and all the other work that running a business entails.

But my cousin/hairdresser/sister-in-law's friend/fave TikToker says they write off all of their personal expenses in their S Corp. They never owe any income tax! What gives?

That's called tax fraud. I highly recommend avoiding that.

Contact me with your questions about S Corporations and I'll help you sort out the facts from the fiction!