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The Tax Benefits of Becoming an S Corporation Versus Sole Proprietor

The main reason business owners form S corporations is because of the tax benefits. First, an S corporation is a pass-through entity—income and losses pass through the corporation to the owner’s personal tax return. The income taxes you’ll pay on your business income, and the business deductions you’ll be allowed to take, differ little from being a sole proprietor. Like sole proprietors, S corporation owners are also eligible for the 20% pass-through tax deduction established under the Tax Cuts and Jobs Act for pass-through business entity owners.

However, not all the money you get from your S corporation can be in the form of a corporate distribution. An S corporation shareholder who performs more than minor services for the corporation will be its employee for tax purposes, as well as a shareholder. A shareholder-employee must be compensated for his or her services with a reasonable salary and any other employee compensation the corporation wants to provide. This salary will be subject to the same amount of Social Security and Medicare tax as the profit earned by a sole proprietor from his or her business.

Relief for Late S Corporation Elections

· Form 2553, Election by a Small Business Corporation, is due no later than two months and 15 days after the beginning of the tax year the election to be taxed as an S corporation is to take effect.

Requirements for Relief under Revenue Procedure 2013-30

Intent - All of the following must be true:

· The corporation intended to be classified as an S corporation as of the effective date of the election,

· The corporation failed to qualify solely because Form 2553 was not timely filed, and

· The corporation has reasonable cause for its failure to file Form 2553 and has acted diligently to correct the mistake once discovered.

Time Limit – One of the following must be true:

· The election to be taxed as an S corporation must be made within three years and 75 days since the effective date, or

· The corporation is not also seeking late entity classification status. (In this case, no time limit applies).

Tax Treatment – One of the following must be true:

· All corporation shareholders have reported their income consistent with S corporation status on all affected tax returns since the effective date, or

· The corporation and all shareholders have reported in-come consistent with S corporation status since the effective date, at least six months have passed since the corporation timely filed its first S corporation tax return, and the IRS did not notify the corporation or any share-holder of any problem with S corporation status during the six months since the first S corporation return was filed.

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1 Comment

Shereen Hamed
Shereen Hamed
Apr 12, 2023

Good article - thanks for putting these concepts into digestible terms.

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