Knowledge Base
Print

S Corporations

s corporationsBy Jason Watson, CPA
Posted Sunday, December 29, 2024

This book is mostly about S corporations so we saved the best for last. The benefits of an S corporation election include-

  • A low audit rate of 0.4% as compared to perhaps 3-5% (yawn)
  • Allowing wages to be paid to the business owner to combat the Section 199A qualified business income deduction phaseout (more on that in a bit),
  • Leveraging the pass-through entity tax (PTET) deduction, and
  • The reduction of self-employment taxes (the big elephant).

Read that again. There is very little difference between a garden-variety LLC and an LLC with an S corporation election from an income tax perspective; the savings of an S Corp is from the reduction of self-employment taxes which comprise of Social Security and Medicare.

Recall that Social Security taxes stop at $176,100 (for the 2025 tax year) but Medicare continues into perpetuity. Don’t laugh! That 3.8% Medicare tax times a zillion dollars is a lot of money.

Spoiler Alert: At $2M in net income after expenses (profit), your S Corp tax savings is still above $60,000 even with a $400,000 salary… all because of Medicare taxes.

Other payroll taxes such as Unemployment, State Disability Insurance (SDA), etc. actually increase by electing S Corp taxation, but they are minor compared to the reduction of Social Security and Medicare (self-employment) taxes.

As mentioned earlier, S corporations are pass-through entities and therefore do not pay federal income taxes directly. However, various states might have different taxes such as a business or franchise tax. Additionally, the shareholders only pay Social Security and Medicare taxes on their salaries, yet do not pay these taxes on the net income after expenses (and shareholder salaries) from an S Corp.

Therefore, you would want a tiny salary and a large distribution from the net income, right? Well, sure, but there is a small little IRS rule called “reasonable shareholder salaries” that we spend an entire chapter on. We’ll also show in a later chapter that S corporations have various sweet spots in terms of income versus payroll tax savings from $30,000 to $2 million, between sole proprietorships, LLCs, partnerships and entities taxed as an S corporation.

S corporations are never formed contrary to popular belief. They are spawned from an entity such as a limited liability company, partnership or C corporation that elects to be taxed as an S corporation. After the election is made on Form 2553, you are treated as an S corporation for taxation purposes only. The underlying entity does not change! A lot of business owners rightfully say, “I have an LLC taxed as an S Corp” but they also say, “I have an S Corp.” Technically the former is more accurate, but both get the point across.

Oddly enough, the equity section in your balance sheet should then have a Capital Stock account and an Additional Paid-In Capital account. Again, while your underlying entity might be an LLC without stock (LLCs have interest not shares), it is being taxed as an S corporation so the balance sheet and tax return should look like a corporation. Yeah, it seems weird to have equity accounts that are for corporations while the underlying entity is a limited liability company. However, this coincides with representing the entity as a corporation for tax purposes, yet the underlying governance might be different. This is the whole S Corp vs LLC conundrum.

We can help with the journal entry to populate these accounts correctly so your equity section resembles that of a corporation. This also helps the tracking of basis in your S corporation. A later chapter has some examples.

To reiterate, you are in a weird limbo with electing to be taxed as an S corporation. You need to walk and talk like a corporation for taxes, but the underlying entity and what the Secretary of State will have on file is going to be an LLC, partnership or C corporation. More on the election, and the behind-the-scenes stuff in a later chapter plus our thoughts on corporate governance such as Meetings and Minutes.

Again, this book is mostly about S Corps. The last couple of pages were a slamma-jamma description of the basics.

Jason Watson, CPA, is a Partner and the CEO of WCG CPAs & Advisors, a boutique yet progressive tax, accounting and business consultation firm located in Colorado serving small business owners and taxpayers worldwide.

Jason Watson CPA LinkedIn     Jason Watson CPA Email

Taxpayer’s Comprehensive Guide to LLCs and S Corps 2025 Edition

LLC's and S Corps bookThis KB article is an excerpt from our 420+ page book (some picture pages, but no scatch and sniff) which is available in paperback from Amazon, as an eBook for Kindle and as a PDF from ClickBank. We used to publish with iTunes and Nook, but keeping up with two different formats was brutal. You can cruise through these KB articles online, click on the fancy buttons below or visit our webpage which provides more information.

$49.95 $39.95 $29.95

Talk to a Small Business CPA About Your Situation

Please use the form below to tell us a little about yourself, and what you have going on with your small business or 1099 contractor gig. WCG CPAs & Advisors are small business CPAs, tax professionals and consultants, and we look forward to talking to you!

The tax advisors, business consultants and rental property experts at WCG CPAs & Advisors are not salespeople; we are not putting lipstick on a pig expecting you to love it. Our job remains being professionally detached, giving you information and letting you decide within our ethical guidelines and your risk profiles.

We see far too many crazy schemes and half-baked ideas from attorneys and wealth managers. In some cases, they are good ideas. In most cases, all the entities, layering and mixed ownership is only the illusion of precision. As Chris Rock says, just because you can drive your car with your feet doesn’t make it a good idea. In other words, let’s not automatically convert “you can” into “you must.”

Let’s chat so you can be smart about it.

We typically schedule a 20-minute complimentary quick chat with one of our Partners or our amazing Senior Tax Professionals to determine if we are a good fit for each other, and how an engagement with our team looks. Tax returns only? Business advisory? Tax strategy and planning? Rental property support?

accounting services for small business

Text WCG Offices

Need to get in touch through a quick text?  We’ll respond back within a day and get going!

accounting services for small business

Call Our Amazing Team

If you need to speak to a tax professional now, give us a call and we'll get you connected.

Previous S Corp Versus LLC
Next Section 199A Qualified Business Income Tax Deduction
Table of Contents