How to Form an S-Corporation
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How to Form an S-Corporation in Nevada
First you need to set up an LLC or Corporation with the Nevada Secretary of State. You can set it up online at http://nvsos.gov/. I recommend using a licensed attorney to help you set up your corporation or LLC because if it is not done properly you could lose the limited liability status of your company.
After forming your company you file form 2553 with the IRS to elect to be taxed as an S-Corporation.
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What is an S-Corporation?
S corporations are corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.
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Requirements to be an S-Corporation?
To qualify for S corporation status, the corporation or LLC must meet the following requirements:
- Be a domestic corporation or LLC
- Have only allowable shareholders
- including individuals, certain trust, and estates and
- may not include partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have one class of stock
- Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international sales corporations.
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How to elect S-Corporation Status?
In order to become an S corporation, the corporation must submit Form 2553 Election by a Small Business Corporation (PDF) signed by all the shareholders.
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What is Self-Employment Tax?
Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.
You figure self-employment tax (SE tax) yourself using Schedule SE (Form 1040). Social Security and Medicare taxes of most wage earners are figured by their employers. Also you can deduct half of your SE tax in figuring your adjusted gross income. Wage earners cannot deduct Social Security and Medicare taxes.
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Who Must Pay Self-Employment Tax?
Generally, your net earnings from self-employment are subject to self-employment tax. If you are self-employed as a sole proprietor or independent contractor, you generally use Schedule C or C-EZ to figure net earnings from self-employment.
If you have earnings subject to self-employment tax, use Schedule SE to figure your net earnings from self-employment. Before you figure your net earnings, you generally need to figure your total earnings subject to self-employment tax.
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Who is an Employee?
The definition of employee for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act) and federal income tax withholding under the Internal Revenue Code include corporate officers. When corporate officers perform a service for the corporation and receive or are entitled to payments, those payments are considered wages.
The fact that an officer is also a shareholder does not change this requirement. Such payments to the corporate officer are treated as wages. Courts have consistently held S corporation officers/shareholders who provide more than minor services to their corporation and receive, or are entitled to receive, compensation are subject to federal employment taxes.
If an officer does not perform any services or only performs minor services and is not entitled to compensation, the officer would not be considered an employee.
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Distributions, Dividends and Other Compensation as Wages
Courts have found shareholder-employees are subject to employment taxes even when shareholders take distributions, dividends or other forms of compensation instead of wages.
In 2001, in a Tax Court case against a Veterinary Clinic, the Tax Court ruled that an employer cannot avoid federal taxes by characterizing compensation paid to its sole director and shareholder as distributions of the corporation’s net income rather than wages. Veterinary Surgical Consultants, P.C. vs. Commissioner, 117 T.C. 141 (2001)
The Sixth Circuit held that a shareholder-employee of a company used the company bank account for personal use. As such, the Court ruled the shareholder was an employee and owed employment tax. Joly vs. Commissioner, 211 F.3d 1269 (6th Cir., 2000)
In yet another similar case, the Tax Court held that an accountant was taking dividends and performing duties for the company. The Tax Court ruled the dividends were actually wages, subject to employment taxes. Joseph M. Grey Public Accountant, P.C. vs. Commissioner, 119 T.C. 121 (2002)
If cash or property, or the right to receive either, did go to the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate.
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