S Corporations are crucial If you’re considering starting a business or looking to refine your company’s structure, you’ve likely encountered various business entity types. In the following article, you will learn about S corps and how could you add value to your business.
What is an S Corp?
An S Corp is a tax status granted by the IRS that allows a business to avoid paying federal income taxes at the corporate level. Instead, income, deductions, and credits flow through to the shareholders’ individual tax returns at their individual tax rates. This structure is designed to avoid the double taxation that typically occurs with C Corporations, where the business itself is taxed on its profits, and shareholders are taxed again on dividends. To qualify as an S Corp, a company must meet specific requirements:
- Be a domestic corporation.
- Have only allowable shareholders, including individuals, certain trusts, and estates. Partnerships, corporations, and non-resident aliens cannot be shareholders.
- Have a maximum of 100 shareholders.
- Have only one class of stock.
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
Key Features of an S Corp:
Pass-Through Taxation: As mentioned, the S Corp’s most significant feature is pass-through taxation. Profits and losses pass directly to the shareholders’ personal tax returns. This avoids the double taxation faced by C Corporations.
Limited Liability Protection: Like other corporations, S Corps offer limited liability protection to their shareholders. This means that shareholders’ personal assets are typically protected from business debts and liabilities.
Corporate Formalities: S Corps must adhere to certain corporate formalities, such as holding regular meetings, maintaining minutes, and filing annual reports. These requirements help ensure that the corporation is operating correctly and transparently. However, these procedures can also increase administrative overhead and necessitate more rigorous record-keeping.
Employment Tax Savings: Shareholders who work for the S Corp can pay themselves a reasonable salary, which is subject to employment taxes. Any additional income can be taken as dividends, which are not subject to self-employment taxes.
Limited to One Class of Stock: S Corps can only issue one class of stock. This restriction can limit the company’s ability to offer different types of stock with varying rights and preferences. However, both voting and non-voting stocks are permitted, regardless of the distribution.
State-Level Taxes: While the S Corp status helps avoid federal double taxation, some states may impose their own taxes on S Corps or disregard the S Corp status, leading to additional state-level taxation.
How to Elect S Corp Status:
To elect S Corporation status, you need to file IRS Form 2553, “Election by a Small Business Corporation.” This form must be filed within two months and 15 days of the beginning of the tax year you want the election to be effective. All shareholders must provide signed consent to the election.
Is an S Corp Right for You?
Incorporating as an S Corp can lend credibility to your business, demonstrating a formal commitment to a professional structure. It also allows for potential growth and additional fundraising opportunities. However, The S Corp structure isn’t suitable for all businesses. Restrictions on the number and type of shareholders can limit your options, particularly if you plan to have international investors or multiple classes of stock.
Deciding whether an S Corporation is the right choice for your business depends on various factors, including your business goals, number of shareholders, and desired tax treatment. Consulting with a financial advisor or a business attorney can provide personalized advice tailored to your specific needs.
If you have any questions or seek further information, feel free to reach out to EPGD Business Law’s experienced attorneys to guide you through the incorporation process.
