If you report your business on Schedule C of your Form 1040, you may notice that the self-employment tax significantly drains your cash! The S corporation may plug a good chunk of that leak because only the W-2 wages that the S corporation pays to you would suffer federal employment taxes. 

How the S Corporation Can Help

The S corporation does three things:

• deducts the W-2 wages
• passes the remaining taxable income to you—the shareholder who reports the income on his Form 1040
• makes cash distributions to you—the shareholder.

The passed-through S corporation taxable income increases the tax basis of your stock. Therefore, distributions of corporate cash flow are usually federal-income-tax-free. 

This tax regime places S corporations in a potentially more favorable position than equivalent businesses conducted as sole proprietorships, single-member LLCs that are treated as sole proprietorships for federal tax purposes, partnerships, and multi-member LLCs that are treated as partnerships for federal tax purposes.

That’s because S corporations can follow the tax-smart strategy of paying modest salaries to shareholder-employees while distributing most or all of the remaining corporate cash flow to them in the form of federal-employment-tax-free distributions.

Still have questions about the advantages of the S corporation? Click here to schedule an appointment with one of Gold Standard's seasoned tax accountants.

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