Selected Tax Considerations for
by SBC Staff
Given the inevitability of
certain approaching tax deadlines, we have seen an increase in questions
from visitors to our website about several tax issues that we feel are
worthy of discussion here. We'll review each of them briefly now. If you
have any questions or want to explore a particular issue in more detail,
please contact us with your specifics and we'll be happy to help.
S CORPORATION ELECTION DEADLINES
If you transact business through a corporation you can choose to make an
election to be taxed as an S Corporation. If you are not familiar with this
election, this may sound like we're getting into complicated territory here,
but relax. It's not that bad.
An S Corporation doesn't pay tax. Its earnings are passed through to the
shareholders who pay tax as if they had earned the income directly. The
earnings of a corporation that has made this election prepares a separate
form for each shareholder of the company that lists the items of income or
deduction that the shareholder must report on his or her individual income
tax return. The corporation's S Corporation income tax return, Form 1120S,
is filed with the IRS along with the Schedules K-1 that list the income to
be reported by the shareholders.
The whole purpose of this scenario is to avoid double taxation of the
earnings of your business; once at the corporate level and a second time
when you withdraw the earnings. This election can save you quite a bit in
In order to be effective for a given tax year, the election must be made by
the 15th day of the third month of the corporation's tax year. So if your
corporation is a calendar year tax filer and you want the election to be
effective for 2002, you need to file the election by March 15, 2002. If you
file later than that, the election will be effective for the following tax
year (2003) and your corporation would still be a regular corporation for
If you create a new corporation during the year, you must file the election
within two months and fifteen days of the first day of the corporation's
taxable year. So if you created the corporation on June 1, 2001, you would
have to make the election by August 15, 2001 for it to be effective for
WHAT HAPPENS IF YOU MISSED THE DEADLINE?
If you have an existing corporation with an established tax yearend, you'll
simply have to wait until the following year for your election to take
effect. You can simulate the same tax results by making sure you pay out all
the corporation's earnings to yourself and the other shareholders before
yearend. This would leave you with zero taxable income in the corporation so
it pays no tax and all of the earnings would be taxed to the individual
owners. However, you might open yourself to an unreasonable compensation
claim by the IRS if your corporation's earnings are very high. Also, you
will have to be able to estimate your corporation's taxable income very
accurately before yearend in order to do this.
If you have a new corporation, you do have another option. A new corporation
can adopt any fiscal yearend it chooses with its first tax return.
Continuing the example above, if you started your corporation on June 1,
2001 and realized on August 16 that you missed the deadline for filing your
S Corporation election, make June 30 your corporate fiscal yearend. File a
return for the short period June 1, 2001 to June 30, 2001 and work with your
accountants to try to make your expenses and income equal for that one
month. There are many accounting methods you can use to do this.
Next, make your election on August 16 for the tax year beginning July 1,
2001 and ending June 30, 2002. Assuming you and the other shareholders are
all calendar year taxpayers, you'll have to agree to change the yearend of
the corporation to December 31 in order to have your election approved. So
you will have a short S Corporation yearend for the period July 1, 2001 to
December 31, 2001. Starting in 2002, your corporation will be a full-fledged
calendar year taxpayer again.
There is a complete article that deals with this issue in more detail on our
website on the Business Articles page.
HOW DO I PAY MYSELF FROM AN S CORPORATION?
Many people believe that since they are taxed on the earnings of the S
Corporation anyway, they don't need to pay themselves a salary. This is not
true. You may get away with it but you are merely playing the audit lottery.
What's the difference you may ask? Employment taxes.
The IRS wants you to pay yourself and the other shareholders regular
salaries and withhold the required taxes just as though the corporation was
a regular corporation. If you are audited, the IRS will assess the taxes you
should have withheld based on what they believe reasonable salaries should
have been. They will also impose severe penalties for failure to withhold
and failure to pay along with hefty interest charges.
Bottom line? Pay yourself and other shareholders who work in the business a
salary. You have a lot of leeway as to how much the salaries should be as
long as you pay something that you can support as reasonable. The IRS isn't
going to be unreasonable with you unless you fail to pay salaries at all.
We hope this information is helpful to you. If you have other questions or
require more details, please do not hesitate to let us know.
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