When should I consider "S" corporation status?

If you already have or plan to start a one-person or closely held business or professional activity, with probable losses during the first-year/second-year start-up period resulting from initial investments in equipment, doing-business materials or inventory, heavy operating expenses, low sales or other income, etc. The S election permits the pass-through of operating losses to shareholders who may have income to offset such losses.

If you already have a business with a high taxable income that distributes the majority of its earnings as dividends and that has low capital spending requirements.

The Federal Income Tax Law of 1993 increased the top individual (personal) tax rate from 31 to 36 percent on taxable income over $115,000 for single people and $140,000 for married couples filing jointly. Income in excess of $250,000 for singles or couples is subject to a 10 percent surcharge, raising their “top” rate to 39.6 percent. Since some exemptions and deductions may be eliminated for high-income people, their true top rate can reach 44 percent.

The federal corporate tax rate for C corporations is 34 percent for firms with taxable income up to $10 million and 35 percent for income in excess of this figure. As indicated under Item 26.2, above, S corporations are not subject to paying a federal corporate income tax.

Therefore, if you anticipate that your individual (personal) taxable income will be less than $115,000, if single, or $140,000, if married filing jointly, you should consider electing S corporate status or forming a Limited Liability Company (LLC) – see Items 31-35, below. However, if your personal taxable income is likely to bump you into the 36 percent bracket or higher, you might be better off forming a regular C corporation, despite the double taxation of dividends by the I.R.S. (and the majority of state governments).

Note: Any company that changes its corporate status generally is prevented by Federal tax law from switching back for five years.