Making the S-Election
Updated: Jan 11, 2021
Based on the current tax environment, the vast majority of small dental corporations are actually “S-Corporations”. The name comes from Subchapter S of the Internal Revenue Code, Chapter 1.
S-Corp vs C-Corp
On the contrary, most large corporations (e.g. PepsiCo) are standard corporations, sometimes called “C-Corporations”. These are companies traded on stock exchanges and have many shareholders, potentially all over the world.
An S-Corp, on the other hand, is limited to only 100 shareholders, and those shareholders must be U.S. citizens or residents. Why? Because of the “pass-through” nature of the S-Corp, and thereby the need to ensure that all income is ultimately taxed in the United States.
In an S-Corp, taxes are not paid at the corporate level. Instead, each shareholder’s share of taxable income is “passed out” on what’s called Schedule K-1. The corporate tax return, therefore, identifies how much net income exists, and then assigns that net income to each owner by reporting it to the IRS. Subsequently, the individual owner reports their share of income on their personal tax returns.
Marginal Tax Rate: Unequal Taxes
Consider an S-Corporation with two unrelated owners, and net income of $100,000. The corporate tax return would report the $100,000 and issue a K-1 for $50,000 of net income to each of the two shareholders. Shareholder A has no other income, while Shareholder B has $500,000 of other income. The $50,000 is taxed differently to each shareholder because it’s taxed at the marginal rate. As a result, Shareholder A may pay $7,500 in taxes while Shareholder B pays $25,000 in taxes!Even as such, the S-election usually makes sense for most dental corporations, but you should review your circumstances with a tax professional.
How to Make the Election
After you’ve completed the incorporation process (described in my other article here), you can proceed with making the S-Election to the IRS via Form 2553. The election can be made as or a certain date, and it’s possible to convert from a C-Corp to an S-Corp. If you’re making the election on your own, be sure to have reviewed your unique scenario with a tax professional before making any decisions.
Dave Sholer, CPA, MBA works exclusively with dentists in California, offering full-service accounting & tax solutions for dental practices of all sizes.
Want more info? Dave offers a no-cost, zero obligation consultation to answer whatever questions you have and/or to review your books, tax returns, and payroll situation. He can review your unique situation to determine if incorporation makes sense, and can even get your corporation set-up and the S-election made, if it is the right move. Additionally, Dave’s full-service model includes all annual corporate filings such that there’s no burden on your life.