The Basics of an S-Corporation

The S-Corporation has become a prevalent entity choice in today’s business environment.
Many people have heard the term, but few outside of the CPA community understand the
mechanics.

The key advantage of an S-Corporation, or S-Corp for short, comes from savings on self-
employment taxes. At some point in their lives, most people have been paid a wage. When
you got that first paycheck, you would have noticed FICA taxes being taken out of the check.

These taxes are for Social Security and Medicare. They are about 7.65% of your wage. Some
people don’t know that the employer also matches the amount you paid and sends this money to the IRS.

So, between you and your employer, 15.3% of your wage is paid for FICA tax.

Assume now that you are self-employed. In this case, you are both the employer and the
employee. So, if you have a net profit of $100,000, you will have to pay $15,300 in self-
employment taxes.

An S-Corp allows some savings on these taxes. With an S-Corp, you can decide how much of
your income you want subject to these taxes. This ability comes with limits, of course. You can
save on these taxes by designating a portion of your earnings as a salary. This is the only
portion that is subject to the 15.3% tax.

The essential rule is, the compensation needs to be reasonable. If you are committed to this business full time, and you are paying a salary that the IRS deems too low, they will decide what they feel is fair and charge you penalties and interest on the difference in tax.

If we assume the same $100,000 in net profit, but you designate $50,000 as wages, your income from your business would be reported on your tax return as follows:

$50,000 in wages from your company (this is reported just like a wage from an employer you
have had in the past.)

$50,000 in pass-through income from your company.

Your company will file a separate tax return that will include a deduction for $50,000 of wages
paid to officers (you). The remaining $50,000 will be reported as pass-through income from
your business on a K-1 form. Your S-Corp does not pay any income tax. The income is just “passed through” to you as the owner and taxed on your personal income tax return.

There are other considerations in electing to be treated as an S-corp that are beyond the scope
of this article. However, this gives you an idea of the main benefit of this tax structure. If you
are considering an S-Corp election, please reach out to us, and we would be happy to explain it
in more detail!

Disclaimer
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, Arrow Advisors would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.