Monday, November 01, 2010

The Return Of The S Corp

In the late 70’s the use of corporate entities to shield business owners from taxes (and other tax shelters) increased dramatically as marginal tax rates hit all-time highs.  Could this type of planning face a resurgence with out of control deficits and the prospects for higher taxes?

An example of this is the S Corporation.  Owners of S corporations can reduce their overall tax bill by paying themselves a salary, subject to payroll taxes (Social Security and Medicare taxes), and then taking a dividend, which is distributed free of employment taxes (and, again, isn't subject to the corporate tax rate). There's a catch, though: that salary must be reasonable, which can be determined by researching salaries in similar industries in the same geographic region. The IRS is well aware that many owners of S corporations are tempted to underreport salary to avoid paying payroll taxes, while taking a hefty payroll-tax-free dividend. To avoid trouble with the IRS, set your salary at a reasonable level based on salaries for comparable positions— and keep careful records in the event of an IRS audit.

To set up an S corporation, you follow the same steps for setting up a regular corporation but take the extra step of electing S status via a special IRS form. To qualify for S corporation status, you must meet certain rules, such as having fewer than one hundred shareholders and issuing only one class of stock (preferred shares aren't allowed).