S-Corp Tax Rates
For small to medium-sized businesses, the S Corporation (S Corp) has become an attractive option due to its unique tax advantages. S Corps are corporations that choose to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. This helps shareholders avoid the burden of double taxation.
Pass Through Taxation
An S Corps defining feature is its pass-through taxation. In contrast to C Corporations, where profits are taxed at the corporate level and again when distributed to shareholders as dividends, S Corps pass profits directly to shareholders. Thus, the company itself does not pay federal income taxes on its earnings, providing potential savings for its shareholders.
Shareholder Tax Rates
As a result of this pass-through taxation, S Corp shareholders report their business income on their individual federal tax returns. As such, the income is taxed at the shareholders’ personal income tax rates which can vary based on the shareholder’s total taxable income and the applicable tax bracket. This arrangement can be beneficial, particularly for individuals in lower tax brackets, as it allows them to avoid the higher corporate tax rates that C Corporations are typically taxed at.
Another factor to consider with S Corp taxation is its relationship with employment taxes. S Corps do not pay employment taxes on shareholder salaries. Instead, shareholders must pay themselves a reasonable salary, subject to Social Security and Medicare taxes, and the remaining profits from the S Corp are distributed to the shareholders as dividends and are not subject to self-employment taxes.
Deciding what is a reasonable shareholder salary for the hours worked and duties performed is important and is not a one size fits all approach. If a shareholder’s salary seems insignificant compared to the S Corps’ profits, the IRS may become suspicious that the shareholder is underpaying their salary and claiming most of the corporation’s income as S Corp profits. If this happens, the IRS may flag the shareholder and, as such, paying a reasonable salary is important to avoid the IRS’s watchful eye.
However, Federal taxes are not the end of the story. S Corp taxation rates can also depend on state and local tax laws, which can vary significantly. Six states do not have a corporate income tax: Nevada, Ohio, South Dakota, Texas, Wyoming, and Washington. However, most of these states, with the exception of Wyoming and South Dakota, have a separate Franchise Tax on a corporation’s gross receipts.
Corporations in Pennsylvania are subject to a Corporate Net Income Tax. This tax is levied on federal taxable income, without the federal net operating loss deduction and special deductions and modified by certain additions and subtractions. From January 1, 1995, through December 31, 2022, the corporate net income tax in Pennsylvania, including Philadelphia, was 9.99%. However, Pennsylvania is in the process of slowly reducing its Corporate Net Income Tax. In 2023, the Corporate Net Income Tax is 8.99% and will be reduced by half a percentage point each year until 2031 when the rate will be 4.99%.
Businesses that elect to be S Corporations under federal tax law are considered Pennsylvania S corporations and are subject to the corporate net income tax only to the extent of built-in-gain. As such, shareholders include their income, losses, and credits from S Corps in their personal income tax returns and pay the 3.07% Pennsylvania personal income tax rate.
How a Tax Attorney Can Help
When establishing an S Corportation, it is essential to structure the business correctly from the start. A tax attorney can assist in determining whether an S Corp is the right choice for your business and guide you through the process of meeting eligibility requirements.
Furthermore, a tax attorney can devise strategies to optimize the company’s tax liabilities and ensure compliance with federal, state, and local tax laws. They can assist in identifying deductions, credits, and exemptions that the corporation may be eligible for ultimately minimizing its tax burden. Additionally, in the event of an IRS audit or other tax related inquiries into the entity, a tax attorney can serve as the corporation’s representative. They have expertise in navigating the audit process, address inquiries, and negotiating on the corporation’s behalf.
And, if circumstances change for the corporation, a tax attorney can guide the corporation through the process of restructuring or dissolution, ensuring that all tax implications are effectively managed and that any potential pit falls are avoided.
Navigating the complexities of tax law for S corps demands a deep understanding of regulations and tax strategies. The team at Premier Legal Services, PLLC bring a wealth of knowledge and experience to the table, guiding S corporations through formation, tax planning, complaince and potential challenges. If you are looking to form an S Corporation or need tax advice on S Corporations, the team at Premier Legal Services, PLLC are here to help. Contact them at (267) 245-0649 or email@example.com for a consultation.