Subchapter S Treatment
We are often requested to form a Wyoming or Nevada corporation with Subchapter Streatment. Subchapter S treatment is a means of Federal taxation whereby the profits of the corporation are passed through to the owners directly so that the owners pay the tax on the profits and not the corporation.
The advantage of this is twofold. First, there is no “double taxation” that would theoretically occur without Subchapter S. (i.e. the corporation first pays corporate tax on the profits and then, upon distribution of these profits to the shareholders as dividends, the shareholders pay personal income taxes on the same funds.) Thus, Subchapter S eliminates this “double taxation” and allows the shareholders to pay income tax only once on the same profits.
Another advantage to Subchapter S is that dividend profits to the owner are not subject to FICA deductions, but employment income is. There is, therefore, the opportunity to set up salaries for the shareholders to reduce the FICA deductions while maximizing the dividend distribution. It is for these reasons that accountants often recommend that their clients set up Subchapter S corporations.
There is, however, an issue that arises when the forming shareholder resides in an “income tax” state but wants to form a corporation in a non-income tax state such as Nevada. When the owner has set up his Nevada corporation as a Subchapter S one, he is now responsible for the payment of his personal State income taxes as well as the Federal income taxes. The result is that the profits of the corporation that would otherwise have not been subject to income tax by Nevada are now being paid to the state of residence of the owner, thereby nullifying the potential benefit to the corporation of the Nevada “no-income tax’ policy.
If one chooses not to have Subchapter S treatment in order to take advantage of the “no-income tax” treatment given to Nevada corporations by the state the owner of the Nevada corporation is then left with profits of the company that, although not subject to State income tax, will be subject to Federal income tax, thus creating the potential “double taxation” sought to be avoided by using Subchapter S treatment. One consolation is that, at this time, Federal tax rate on corporations is 15% on $50,000 of profits and 25% on profits of $75,000. These rates are usually well below the personal tax rates of the owners who pay at that rate if there were no Subchapter S treatment.
It should be noted that those clients who live in states that have no personal income tax such as Florida, Texas and Washington can take advantage of Subchapter S treatment and may even obtain this treatment for an LLC by having the LLC taxed as a corporation..
If the owner of the Nevada corporation chooses the latter course of no subchapter S treatment, those owners should make every effort within the tax laws to take as many deductions as are allowed to reduce the profits of the corporation while not incurring any more personal income tax than necessary on their own accounts.
Corp95 is the premier incorporation service company for Nevada corporations in the country and our counselors are always available to speak to you and answer any questions you might have before making a commitment to incorporate. We can also incorporate you in any state of your choosing at very reasonable fees.