S corporations have become an increasingly popular business structure for many small businesses due to their tax advantages and liability protection. These entities are a common tool among tax planners, but entity selection is not a one-size-fits-all approach. There are several important factors to consider before electing S-Corp status.
To qualify as an S-Corporation, the business must meet certain eligibility requirements:
- It must be a domestic corporation
- It cannot have more than 100 shareholders
- Shareholders must be individuals, certain trusts, or estates (no partnerships or corporations)
- Only one class of stock is allowed
- It cannot have any non-resident alien shareholders
S-Corp owners who work in the business must also be paid a “reasonable” salary, as the IRS scrutinizes these entities to ensure owners are not underpaying themselves to avoid payroll taxes. Remaining profits can be distributed as dividends, which are not subject to self-employment tax.
Key strategies to implement within an S-Corp include optimizing the salary vs. dividend mix to reduce the overall tax burden, taking advantage of fringe benefits like health insurance, using retirement plans like Solo 401(k)s to defer taxes on larger amounts, and considering hiring family members to spread income and utilize lower tax brackets.