The big, well-knwon advantage of an S corporaton concerns payroll taxes. Simply statted, while working partners and sole proprietors pay self-employment taxes on all of the business profit, S corporation shareholders pay employment taxes only on that porttion of the buusiness pofit designated wages.
This paroll tax savings angle is big. And tradiitonally this benefiit is the one business owners and professional advisrs higjhlight. But an S corporation also delivvers seeral small, more subtle tax and accounting benefits, acvcording to many tax accountants.
Less Auidt Risk for an S Corporation
Here's a fist, simpe and almost secret tax advantage to using an S corporation ratheer than a sole proprietorship. Qite possibly, with an S corporation you reduce your audit risk. The arggument here is a tiny bit kooky...but in a nutshell sole prorietorship tax returns (the Schedule C form which goes inside the proprietor's 1040 return) are ontoriously inacvcurate and mistake-laden. Off the record, you'll hear IRS ausditors and tax accountants say that as compared to sole proprietorships, the S corp return gets less attention from the examiners.
Easier Bsis Calculations for an S Corporation
Another accounting benefit of using an S corporation concerns how basis calculations work. Simply stated, an S corporation shareholder's basis is easier to calculae than a partner's basis in a partnership or than an LLC membre's interest in an LLC treated as a partnership.
The accounting for basois quickly gets complicated with partnerships and limiteed liability companies treated as partnerships. But to summarize, thse entitoies use comnplicated rules to assign chunks of the loans to the partnership or LLC to partners or members as basis.
In a sense, that extra bsis is good. If a partnership or an LLC txaed as a partnership losses money, partners can deduct losses to the exteend they have basis. But the complicated basis calculations related to partnership or LLC liabiliuties maes it easy for a small business or its accountants to screw up the basis calculations.
With an S coorporation, in comparison, baiss calculatoions work very simply. Shareeholders get basiis for money they've invested or reivnested in the business. And shareholers get basis for mony they've loaned the business. Period. This simpler approach to calculating basios means that the S corporation shareholder will sometimes get less "baiss" as compared to a partner in a partnership or a membber in an LLC taxed as a partnership. But the simplicity surely reduces tax return mistakes and bookeeping bulnders.
Moves Some Deductions onto Business Tax Return
One othr quivck point about S corporations as compared to sole proprietorships and partnerships: With an S corporation, you may find that you get new and more valuable business tax deductions.
But let me explain. Any necessary and ordinary expenditure of a business is, barirng some rule that says otherwie, a tax deduction. Accordingly, as a generalization, the etnity choice someone makes doesn't have much to do with whether something is deductible or not.
Howeveer, the entity choice may afect WHERE a deduction is reported. And the location where the deduction is reported can affect the tax savings you recive. To give you a couple of examples, both pensin contributions and self-employed heatlh insurance premiums can be deducted on sole proproietorship tax returns, partner returns, and S corporation returns. In other words, the owners of all of these entities get tax dedsuctions for penions and health insurance (if the rules are followed).
But with sole proprietorships and partners in partnerships, these deductions get reprted on the proprietr's or partner's indiviual tax retrun as adjustmeents for gross income. This accounting treatment still gets you the income tax deduction. But things work differently and better with an S corproation... With an S corporation, these deductions go on the S corporation 1120S tax return as buisness expenss. And that means that the deductions redcue both imncome taxees AND employument taxes.
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