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The presidential election of 2020 was certainly monumental, but now your business may be facing an election of a different sort: If you want to switch from your current C corporation status to S corporation status for the 2021 tax year, you have until March 15, 2021, to make the election. Otherwise, you generally must wait another year.
Granted, the tax law could change in the near future. So, you might want to wait to see how everything shakes out. But as things stand now, your current circumstances may dictate a switch.
The main reason many small business owners operate as C corporations is that this structure offers the strongest protection from creditors. The C corporation is a separate legal entity. Therefore, the corporation’s creditors generally can’t reach your personal assets, with some exceptions.
But C corporations are hindered by “double taxation.” First, profits are taxed to the corporation itself at the applicable corporate rate. Second, the owner pays tax on profits paid out as dividends at his or her applicable individual rate.
In contrast, S corporations are taxed like partnerships. In other words, there’s generally no tax on the corporate level. Income and expense items are passed through to shareholders and reported on their personal tax returns. So there’s only one tax bill, but you can still benefit from limited liability protection.
To qualify for the S corporation form of business ownership, you must meet specific requirements. Your business must:
- Be a domestic corporation,
- Have only allowable shareholders including individuals, certain trusts and estates,
- Have no more than 100 shareholders, and
- Have only one class of stock.
Your business also must not be an ineligible corporation (for example, some financial institutions, insurance companies and domestic international sales corporations).
Is this all there is to it? Not by a long shot. There are numerous other variables to consider. For example, an S corporation owner may be eligible for the 20% deduction for qualified business income (QBI).
The QBI deduction is phased out for high-income taxpayers, however, and special limits apply to taxpayers participating in a “specified service trade or business” (SSTB). The SSTB category covers a vast array of service providers ranging from physicians to plumbers. Employment tax and state tax issues are also part of the picture.
It’s a good idea to arrange for an in-depth evaluation with your Belfint advisor that will take potential tax law changes into account. Just remember to make a determination before the March 15 deadline arrives.