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Advantages of S Corporations

1. Double taxation is avoided
Double taxation occurs when a corporation pays income tax on corporate net income, and then the shareholders pay tax on any dividend income they receive from the corporation (This often occurs with C corporations). Double taxation hits particularly hard when a company is sold.

By becoming an S corporation, profits and losses flow directly through to the owners in proportion to their ownership percentages. For example, a 10% owner would receive 10% of the profits or losses.

Since profits and losses flow through and are taxed on the individual, there is no federal tax on the corporation itself. California does tax S corporations on the corporate level, but at much lower rates than C corporations. The remaining income flows through to the shareholders for a second layer of California taxation.

2. Avoidance of self-employment tax by the shareholder of the corporation
Sole proprietors and independent contractors are subject to self-employment tax at a rate of over 15%. A self-employed person who forms an S corporation and becomes an employee of that corporation is no longer subject to self-employment tax because that person will no longer be self-employed. This applies even if that person is the corporation's sole shareholder and employee.

However, reasonable wages are required to be paid to the shareholder/employee and payroll taxes must be paid on this amount.

(This information is designed to be of general interest.  The specific techniques and information discussed may not apply to you.  Before acting on any matter contained herein, consult with your professional advisor.)


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