What is an "S" Corporation?

When you establish your business operations you must consider what legal structure your business will be. Considerations should include: limited liability from law suits of customers and associates, limiting the amount of taxes you pay on business income, and how you define the allocation of ownership and allocation of profits. An "S" corporation provides the best answer to all of these questions for a small business owner because it provides limited liability of a corporation, it saves owners from double taxation as is the case with a regular "C" corporation, and it allows ownership and profit allocation through the issuance of stock.

What is the advantage from other structures?

"S" corporations do file tax returns but do not pay income tax. The taxes are assessed on the owners' share of the profits allocated to them as it is reported on the "S" corporations form K-1. This income is treated basically as dividend income to the owners so there is no self-employment tax assessed.

So the owner avoids self-employment tax?

If the owners only distribute profits and don't pay salary, which would require Social Security and Medicare taxes equivalent to self-employment taxes, then they only pay income taxes on the profits in the form of dividend income. This allows the owners to avoid self-employment taxes. However, there are exceptions to this rule. It is called the “reasonable compensation” rule. Small businesses starting out have to stabilize there income first in order to determine a reasonable salary. This can be done within the first or second year depending on the level of income and many other circumstances. An Experienced CPA is the best person to make a determination for you, regarding when and how much salary should be paid.