Creating Business Plans For An S Corporation

Recent IRS statistics show that the S corporation is the most popular corporate form for doing business in the US. Accordingly, entrepreneurs benefit from knowing the differences between business planning for an S corporation and planning for a traditional, or C, corporation.

Business Planning Difference #1: No Corporate Income Taxes

If you work with standard business planning software, one of the key variables you input is the corporation's income tax rate. And that makes sense. After a business venture is profitable, corporate income taxes become an important expense and cash flow item to include in the planning.

S corporations typically avoid state and federal corporation income taxes. This "zero corporate taxes" feature means, therefore, that when doing business tax planning for an S corp, you typically should not budget for corporate tax payments.

Note: Some states like Tennessee treat S corporations like regular corporations, which means that these corporations in Tennessee do pay state corporate income taxes. Other states in which an S corporation may pay income or income-like taxes on its income or some portion of its income include Michigan and Massachusetts.

Business Planning Difference #2: Distributions for Individual Income Taxes

The profit that an S corporation earns ultimately does get taxed, by the way. What happens, in effect, is that the S corp assigns its profit to shareholders based on their ownership percentages.

Later on, when the stockholders compute their taxes, they will pay the income taxes on those "assigned" corporate profits. A shareholder who owns, for example, twenty of the corporation pays the income taxes on twenty percent of the corporation's profits.

And this fact affects the S corporation business plan. Because S corp owners pay the income taxes on the business's income, the business plan should explicitly budget for shareholder distributions so the owners can pay the income tax bill due because of their respective shares of the profits.

Note: When planning distributions to pay for the shareholder income taxes on S corp profits, you would commonly use the highest individual marginal income tax. That assumption would mean that all shareholders receive enough money to pay the tax bill.

Business Planning Difference #3: Franchise Taxes

A quick planning point: A handful of states levy franchise taxes on S corporations. And an S corporation will owe franchise taxes to any state in which it operates, employs people or owns property.

Accordingly, when doing business planning for an S corporation, you do want to consider the issue of state franchise taxes. Thankfully, the franchise taxes are usually modest--at least as compared to federal income taxes.

Business Planning Difference #4: Plan for S Status Termination

A final business planning point related to S corporations. These corporations can only have certain types of shareholders--essentially US citizens and permanent residents--and can have only a limited number of shareholders.

Note: The shareholder limit is sort of 100 or fewer shareholders, but families often count as one shareholder, so the shareholder count can, practically speaking, rise above 100.

These S corporation eligibility rules mean that if you're doing business planning for an S corporation that will become or may become very successful, you ought to consider the possibility that, at some point, the S corp status will terminate.

For example, an ineligible S corp shareholder like a venture capital partnership or corporate investor might acquire shares. (A partnership is not an eligible shareholder.) Or perhaps at some point, the S corp shareholder count will exceed 100 shareholders.

When the S corporation status terminates, the corporation will begin paying taxes on its profits and shareholders will stop paying taxes on the corporation profits.