S-Corporation Case Study

A S-Corporation is a closely held corporation that makes an election to be taxed under Subchapter S. Generally, S-Corporation is pass-through entity, which means the corporation’s income and losses passes through to you and you must report those on your individual income tax returns. S-Corporation shareholder who is actively engaged in the business is owner/employee. As an employee, you receive compensations for your services and are only personally responsible for 7.65% social security and Medicare tax, and the company pays the remainder of the tax (7.65%) which total 15.3% cannot be avoided. Distributions that are not compensations from S-Corporation to its owner are not subject to self-employment tax. This ability to avoid social security and Medicare taxes, or self-employment taxes on distribution amount is the huge benefit for an S-Corporation. You need to compensate yourself a reasonable amount for the work that you do for S-corporation as IRS pays attention closely at S-Corporations returns since the potential for abuse is too large.

In IRS Fact Sheet 2008-25, IRS summarized the factors considered by the Eighth Circuit and advised S-corporations to consider them in establishing reasonable compensation of the …show more content…
An LLC is also a pass-through entity, which means your entire portion of profits and losses passes through to you and you must report those on your individual income tax returns. Rev. Ruling 69-184, IRS states that member of the partnership is not an employee of the partnership so the right way to compensate the member for his services is to pay him “guaranteed payments” (section 707) and it is subject to self-employment tax like his share of entity’s profits. Thus, there are no tax advantages to establish as an LLC. If you elect to establish LLC, you will need to pay self-employment tax for your portion of entity’s profit and guarantee payment that you will receive for your