Benefits of Being Taxed as an S Corporation over a Sole Proprietor/Partnership

May 23, 2024

Benefits of Being Taxed as an S Corporation over a Sole Proprietor/Partnership

The Benefits of Being Taxed as an S Corp over a Sole Proprietor/Partnership.

Witnessing the transformation of an idea into a thriving business is an exciting milestone for any entrepreneur. However, you need to establish a solid business structure to lay the groundwork for this. Successful entrepreneurs focus on the long-term process and must be comfortable with encountering some level of risk to earn the rewards of their efforts. They also require an understanding of structured experimentation. 

Fundamental Business Structures to Know.

There exist four fundamental business structures:

  • S Corporation
  • Sole Proprietorship
  • Corporation
  • Partnership

Each of these structures comes with its own set of tax and income regulations. They also come with differing levels of liability.

These distinctions play a direct role in shaping the operational and financial landscape of a business. Therefore, conducting thorough research before getting into the launch phase is a prudent course of action.

Many business owners form LLCs.  The most common mistake is to do nothing after the formation.  If this happens, you default to either a Sole Proprietor or a Partnership as a “Disregarded Entity” in the eyes of the IRS.

You have 65 days from your formation to elect to be taxed as a Corporation as an LLC, if not, you need to wait until the first 65 days of the beginning of the next calendar year


Benefits of Being Taxed as an S Corporation Over Partnership or Sole Proprietorship

Here are the benefits of being taxed as an S Corporation:

Tax Benefits for S Corporation

S corporations enjoy the benefit of pass-through tax benefits at federal level. Unlike C corporations, S corporations are not subject to double taxation. This means that S corporations do not pay taxes on their company profits, except for some specific passive income and built-in expansions.

In fact, the tax liability for income generated by business, along with credits, deductions, and losses, is passed to the shareholders and employees directly. This taxation structure is similar to what you can see in partnership or a sole proprietorship.

Save More on Self-Employment Taxes

One of the advantages of operating as an S Corporation is the potential for tax savings on self-employment taxes. Unlike distributions, which are not subject to self-employment taxes, reasonable compensation paid as salary is subject to these taxes.

Many small business owners elect to be taxed as an S Corporation to limit their Self Employment tax liability.  However, make sure you have an Accounting Firm helping you with the process and making sure you are paying the owner’s a Reasonable Compensation.


State Tax Considerations

It is important to note that S corps may be treated otherwise at the state level than at the federal level.

For example, you may have an S corporation situated in Jacksonville, Florida. It pays income tax IRS Form 1120S on line 22c. The company also needs to file a Corporate Tax return in Florida.

S corporations may be liable to pay corporate income tax depending on the state. It happens at a specific rate for income earned within that state. It is advisable to consult with an accounting professional to determine the specific tax implications applicable to your S corporation at the state level.

Limited Liability Protection

Another significant advantage of operating as an S Corp is the limited liability protection it offers to shareholders. Partners and sole proprietors are liable for their businesses’ obligations and the debts personally. However, S Corp shareholders are generally not personally responsible for the liabilities of the company.

This means that their assets are protected in case of a lawsuit or bankruptcy. It provides an added financial security and peace of mind.

Maximizing Tax Benefits with S Corporation Health Insurance

Choosing S corporation status offers significant advantages when it comes to health insurance premiums. If a spouse of a shareholder-employee is not eligible for sponsored health insurance, the S corporation can cover premiums of family health insurance from employee’s wage package.

This arrangement allows both the employee and the employer to deduct the health insurance payments from the income of employee before finalizing self-employment tax.

Additionally, the employer can claim the amount paid as a deductible wage expense. It ultimately helps in avoiding taxation on this expenditure.

Transferring Ownership

Transferring ownership of an S corporation is a straightforward process. The interests in the corporation can be transferred to the new owner(s) when the time comes to sell. It can be done without facing complex or costly tax implications.

Unlike sole proprietorships, S corporations have the advantage of being able to outlast the owner’s lifetime. This makes it easier for the owner to plan for succession or the sale of the business upon retirement.

Final Thoughts

It offers multiple benefits to be taxed as an S corporation. The S Corp structure provides a compelling framework for small business owners to thrive and grow. This is possible due to multiple reasons from tax savings to limited liability protection.


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