Choices For Small Business

Only taking tax issues into consideration, small businesses have a difficult decision on when to either incorporate or organize as an LLC. For tax purposes, an LLC can be a single member, treated as a sole proprietor; a partnership, the default for a multi-member LLC; and a corporation or S-corporation. Your circumstances will determine how you wish to organize your business.

Most businesses are organized as an LLC, electing for the tax treatment of choice. As a rule of thumb, a very small business with a small profit or loss should default to a single member or partnership. Once a business has earning of $50,000, an S-corporation has advantages over other forms of taxation.

Organizing your business as an entity has long reaching ramifications. The decision should not be taken lightly. It is important you have a serious conversation with your friendly local accountant on how your business is organized. Delays can add to your tax burden. With increased complexity in the tax code, a regular consultation with your tax advisor is advised.

S-Corp Dividend Rules

One of the nicest things S-corporations offers is tax-free dividends. Unlike, partnerships, regular corporations, and sole proprietorships, distribution/dividends paid out of profits above wages are not subject to self-employment or FICA taxes.

Example: XYZ is an S-corporation with two shareholders/owners and five additional employees. XYZ has $150,000 in profit before shareholders/owners are paid. Each shareholder/owner is paid a $50,000 wage, plus a $25,000 distribution/dividend. The wage is handled like any other employee wage. The dividend is only subject to ordinary tax, no FICA or self-employment tax; about a 15% savings, or $7,500 per owner.

When I tax plan with S-corp clients I sometimes have a hard time convincing them to pay a dividend rather than all wages. The IRS says S-corps must pay a reasonable wage before dividends are paid. Reasonable is a wide road and requires careful consideration. Once your S-corp pays you a reasonable wage, it is time for dividend distributions of additional funds. The savings can be significant.

Don’t overpay your taxes because you don’t understand the value of the S-corp. Invest time with your friendly accountant and build a plan for the greatest tax savings. The rules are many when it comes to S-corps and the opportunities are equally great. You don’t need to understand basis, debt basis, flow-through income, etc. to take advantage of the benefits. You need a good accountant that lays out what is available to you and how to accomplish the goal.

I encourage you to take this post to your accountant if you have an S-corp. Allow him/her to explain what I outlined above as it relates to you.