S Corp Introduction
What’s an S Corp?
Fun fact, an S Corp, or S Corporation, is not a legal structure. Rather, it’s a tax election that businesses use to determine how they’ll be taxed on the federal and state levels. Business owners can operate as a Sole Proprietorship, where no formal state registration is required, or register their business as an LLC or Corporation.
The IRS assigns a default tax treatment to LLCs and Corporations, which means the IRS decides how these structures will be taxed. Both have the option to change their tax treatment and elect to be taxed as an S Corp. Under the rules of S Corp taxation, the business’ net income is not taxed at the business level. Instead it’s “passed through” to the owners’ personal tax returns.
Benefits of an S Corp
When an LLC chooses to be taxed as an S Corp, it allows its owners to earn a salary as well as take distributions of profits, which are subject to different tax treatments. This is where the magic happens!
Your S Corp salary is subject to both Social Security and Medicare taxes and income tax. The remaining business profit is only subject to income tax. The punchline: you don’t have to pay Social Security and Medicare taxes on your business profits, which can save you money at tax time.
S Corp Considerations
An S Corp is a more complex tax structure, so there are a few things to be aware of:
Tax Filings: As the owner of an S Corp, you’ll file an S Corp tax return (Form 1120-S) as well as a personal tax return (Form 1040). (Included in Collective’s Services)
Owner’s Salary: This is what you pay yourself via payroll and is facilitated through Collective Payroll. At the end of the year you’ll receive a W-2 reporting your owner salary wages. Keep in mind that the IRS requires that you pay yourself a reasonable compensation via your owner’s salary. (Included in Collective’s Services)
Quarterly Taxes: You’ll pay these throughout the year, which will go towards your annual tax liability for your personal taxes. (Collective provides quarterly tax recommendations)
Salary & Distributions
As an S Corp owner, the IRS views your business as an entity separate from yourself. That means you’re no longer subject to paying self employment tax on your business profits.
Under the rules of an S Corp, you can become both an owner and employee of your company.
The IRS requires a diligent effort in paying yourself a “Reasonable Compensation” (aka owner’s salary facilitated through Collective Payroll). How much should you pay yourself? There’s no set formula, but studies indicate a healthy business utilizes one third of its revenue for regular operating and payroll expenses. The remaining two thirds is held as profit.
Click here for more IRS guidance on reasonable compensation
In addition to your salary, you can draw money out of your business through distributions. Distributions do not affect your income or expenses and generally there are no direct tax or profit consequences to removing cash from your business bank account.
Remember, as the sole owner of your S Corp, you’ll be paying taxes on your income in the year it is earned, not when you take money out of the business. Here’s how to take a distribution:
Transfer the cash from your business bank account to your personal bank account
Collective’s bookkeeping team will classify this transaction as a “shareholder distribution” in your bookkeeping software (Xero or Quickbooks)
How does my S Corp relate to Collective’s process?
The S Corp is at the center of everything Collective does. Our primary goal is to help keep you in compliance with the IRS so you can run your business with peace of mind.
Here are the services included in your Collective membership:
LLC Formation and S Corp Tax Election
If required, you can use Collective’s platform to create an LLC in your state of residence and acquire a Federal Tax ID number to identify your LLC with the IRS. Then we file your S Corp Election (Form 2553) with the IRS.
Through Collective Bookkeeping (powered by Xero), we provide monthly transaction categorization and account reconciliation. You can also access monthly financial statements, giving you an up-to-date financial picture of your business.
Before setting up your payroll account, Collective facilitates filing of your employer registration documentation at the state level. This critical step allows each member to smoothly begin running payroll.
We provide an easy system to set up and update your payroll and contractor payments. Collective Payroll powered by Gusto handles all of your quarterly and annual payroll compliance requirements.
You’ll be able to access estimated federal and state tax payments each quarter.
Annual Tax Compliance
The Collective Tax Team prepares, reviews, and files your S Corp/business tax return (Form 1120 S). Depending on the complexity, Collective’s Tax Team can also file your personal tax return.
Retirement Plans and Health Insurance
Collective’s team of experts will guide you through setting up your payroll to capture tax-beneficial health insurance premiums and payroll processed retirement contributions.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or financial advice.