Why choose an S corporation?
S corps are corporations that have elected a special tax status with the IRS. S corporations provide the same limited liability to owners (called shareholders) as C corporations, meaning that owners typically are not personally responsible for business debt and liabilities; however, S corporations have pass-through taxation. S corps do not pay tax at the business level, they file an informational tax return but business income/loss is reported on the owners’ personal tax returns, and any tax due is paid at the individual level.
S corp advantages
Forming an S corporation has many advantages. Many small business owners form a corporation and elect S corp status for pass-through taxation. Other typical advantages of forming an S corporation include:
- Limited liability protection. Owners are not typically responsible for S corporation business debts and liabilities
- Easy transfer of ownership. Ownership is easily transferable through the sale of stock.
- Unlimited life. When a S corporation’s owner incurs a disabling illness or dies, the corporation does not cease to exist.
- Pass-through taxation in the corporate form. S corporation tax status avoids the “double-taxation” associated with C Corps and instead provides S corp owners with pass-through taxation benefits.
- Raise capital more easily. Additional capital can be raised by selling shares of stock.
- Credibility. S Corps may be perceived as a more professional/legitimate entity than a sole proprietorship or general partnership.
- Pro-rata distribution of profits. Under IRS S corp taxation rules, profits, losses and other pass through items are allocated based on each shareholder’s proportionate shares of stock.
- Income and losses passed through to shareholders. Income and losses of S corps are passed through to shareholders, similar to the way income and losses of partnerships are passed through to partners.
- Lower audit risk. Generally S corps are audited less frequently than sole proprietorships.
- Tax deductible expenses. Business expenses may be tax-deductible.
- Self-employment tax savings. An S corp can offer self-employment tax savings, since owners who work for the business are classified as employees.
S corporation ownership restrictions
Per IRS guidelines, S corporation owners (shareholders) must meet the following criteria:
- Number 100 or less.
- Must be US citizens/residents (cannot be non-resident aliens).
- Cannot be C corporations, other S corporations, limited liability companies (LLCs), partnerships or certain trusts.
Other IRS restrictions, apart from ownership restrictions, also apply to S corporations. For example, there can be only one class of stock (but differences in voting rights are permissible) and the corporation must be a domestic corporation.
How do you form an S corporation?
In order to register a business as an S corporation, Articles of Incorporation (sometimes called a Certificate of Incorporation), must be filed with the state and the necessary filing fees paid. After incorporation, Form 2553 must be filed with the IRS in order to elect S corporation status.
Also after incorporation, S corporations are also required to adopt bylaws, hold an initial meeting of directors and shareholders, and issue shares of stock to owners.
Key Benefits of forming an S corporation
Electing S corporation status with the IRS allows for pass-through taxation of the corporation’s profits. S corps must still file corporate tax returns, but they do not pay taxes at the corporate level. The S corporation’s profits are passed-through to the individual tax returns of the shareholders, and taxes are paid on those profits at the individual tax rate. S Corporation vs. C Corporation: A Comparison
Keep in Mind
S corporations must make a timely filing of Form 2553 with the IRS. The form must be completed and filed any time before the 16th day of the 3rd
month of the tax year in which the election is to take effect, or any time during the tax year preceding the tax year in which it is to take effect. BizFilings can obtain S corp status on behalf of your business as part of our Complete Incorporation Service for S corporations.