In an S-Corporation, only earnings actually paid out to an owner as compensation for services are subject to payroll taxes. Any money left in the business for reinvestment or distributed to the shareholder as a dividend is not subject to payroll taxes...and not subject to self-employment tax.

Let's review an example:

"George" operates his business as an unincorporated, sole proprietorship. George has a net income (gross income less expenses) of $60,000 during the year. During the course of the year, John withdraws $40,000 as his personal salary leaving the remaining $20,000 in the business. If George operates as a sole proprietorship, he'll owe self-employment tax on the full $60,000 ($60,000 x 15.3% = $9,180).

However, if George forms a corporation, elects S-corporation status, and withdraws the same $40,000 as compensation for his services, he would only owe self-employment taxes on the $40,000 in salary ($40,000 x 15.3% = $6,120). Thus, forming an S-Corporation would save John $3,060 in payroll/self-employment taxes.

Let's First Start off with Explaining What an S-Corporation is....

An S-Corporation begins its existence as a general, for-profit corporation upon the filing of Articles of Incorporation at the appropriate state office. Once formed, a general for-profit corporation that has not requested "S-Corporation Status" with the IRS will be required to pay income tax on taxable income generated by the corporation. In addition, any dividends distributed to shareholders may be subject to taxation as dividend income to that shareholder as well (hence the problem of "double taxation" that can occur in a 'Non-S-Corporation').

After the corporation has been formed, it may elect "S-Corporation Status" by timely submitting IRS form 2553 to the Internal Revenue Service. Certain states require that your corporation file state-specific forms to qualify for S-Corporation status in that state for state taxation purposes. In addition, S-Corporation status is not available for purposes of state tax liability in certain states. Please contact your state's taxing authority for further information.

Once this filing is complete, the S-Corporation is taxed in a manner similar to a sole proprietorship or partnership, rather than as a separate entity. Thus, the income is "passed-through" to the shareholders for purposes of computing tax liability. Therefore, each shareholder's individual tax return will report the income or loss generated by the S-Corporation.

Who typically elects S-Corporation status?

Most entrepreneurs prefer the S-Corporation structure for the following reasons:

• The S-Corporation combines many of the advantages of the sole proprietorship, the partnership, the corporation, and the LLC into one entity.
• Unlike sole proprietors and partners in a partnership, shareholders of an S-Corporation are afforded the same level of limited liability and personal asset protection as are the shareholders of a general, for-profit corporation.
• In an S-Corporation, shareholders avoid the "double-taxation" common to shareholders of non-S-Corporations because all income or loss in an S-Corporation is reported only one time on the personal income tax returns of the S-Corporation's shareholders.

Where a corporation claims income from a passive investment (e.g. from real estate owned) for three consecutive years that exceeds 25% of the corporation's gross receipts, S-Corporation status may be terminated by the IRS. Many real estate investors prefer placing real property in an LLC (Limited Liability Company) rather than an S-Corporation for this reason.

What Requirements to Qualify as an S-Corporation exist?

To qualify for S-Corporation status, the corporation must

• Be filed as a U.S. corporation.
• Maintain only one class of stock.
• Maintain a maximum of 100 shareholders.
• Be comprised SOLELY of shareholders who are individuals, estates or certain qualified trusts, who consent in writing to the S-Corporation election.
• NOT have a shareholder who is a non-resident alien.

Note: Failure to observe ANY of the above requirements could revoke S-Corporation status at any time.

What are the differences between an S Corporation and an LLC?

While on the surface the S-Corporation and the Limited Liability Company ("LLC") may seem similar, but please note the following very significant distinctions. The following are some of the differences between the two types of corporate entities:

• S-Corporations are limited to 100 shareholders.
• LLCs have no limit to the number of members.
• S-Corporation shareholders must ALL be individuals who are U.S. citizens or permanent resident aliens.
• LLC members (owners) may be individuals, corporations, partnerships, many trusts, and even non-resident aliens.

The "S-Corporation" Deadline:

To qualify as an "S-Corporation" for the 2008 tax year, a "calendar year" corporation must timely file IRS Form 2553 with the IRS.

If a corporation was in existence in 2007 or earlier, then this filing must be submitted to the IRS on or before: March 17, 2008

If the corporation is a "New Corporation" (formed on or after 1/1/2008), then the S-Corporation election may be submitted at anytime during its tax year so long as the filing is made no later than 75 days after the corporation has begun any of the following activities (whichever is earliest):

• Conducted business as a corporation
• Acquired assets, or
• Issued stock to shareholders

For existing corporations, the form must be submitted to the IRS by March 17th. If you are filing for a new corporation, you must submit this form within 75 days of when your corporation first acquires assets, begins conducting business or issues shares to its shareholders.

Important: As with any important legal matter, you are strongly urged to contact a licensed professional before making any decisions that could impact your tax liability. Please see your accountant or financial advisor for advice as to whether your corporation will qualify for S-Corporation status.