Benefits of S Corp: Everything You Need to Know
The benefits of S Corp entities are compelling for many small businesses. In S-Corp, the "S" comes from the governing section of the IRS tax code. 4 min read
The benefits of S Corp entities are compelling for many small businesses. In S-Corp, the "S" comes from the governing section of the IRS tax code. The section allows for certain benefits for qualifying S corporations. However, you have to know these benefits to fully take advantage of incorporating as an S corporation.
What is an S Corporation?
According to the Internal Revenue Service (IRS), S corporations receive the benefits of being a pass-through entity. This means the funds earned by the company are passed through to the owners and they are then taxed on the income. An S corporation is not a business entity or structure.
To receive S corporation status:
- You first incorporate by filing Articles of Incorporation with the Secretary of State in the state where your business operates.
- You elect S-Corp status by filing an IRS Form 2553.
You have to file the form with the IRS within 75 days of filing the incorporation documents, or 75 days before the tax deadline of the year you want the consideration. S corporations operate similarly to their C corporation counterparts. There are officers, shareholders, directors, and employees with the same function as in a C corporation.
Benefits of Electing S-Corp Status
The shareholders of S-Corps have limited liability protection like C corporation owners, as well. So, creditors are unable to go after the personal property of the owners, unless the person gives express guarantee for the creditor and transaction.
Growing small businesses often elect the S corporation status due to the overwhelming advantages that general partnerships and sole proprietorships do not have. Companies enjoy additional benefits when they decide to transfer ownership in the company. General partnerships and sole proprietorships generally do not enjoy these same benefits.
The business expenses and losses may offset the income of shareholders on their yearly federal tax return. S corporation status helps business owners avoid "double taxation," a term used to describe corporation earnings taxed at the corporate level and at the personal level when owners file their returns.
Before an S corporation is profitable, it must pay all employee-owners who work for the company a competitive salary for the industry. The required Social Security and Medicare taxes charged for employment are paid by the company on behalf of the employee.
For start-ups, S corporation status is beneficial. If you create passive income and do not take advantage of S corporation status, you open yourself up to the risk of being considered a personal holding company when it comes to filing federal income tax with the IRS.
Some of the S corporation advantages are:
Meaning, the "corporate veil" that protects corporations is not pierceable. The personal property of the shareholders is protected. The term "corporate veil" is a term associated with the limited liability protection a corporation offers.
As previously mentioned, S corporations enjoy the benefit of pass-through taxation. There are federal rules governing S corporations that most states follow. Tax deductions, losses, and business income are passed to the owners instead of the corporation being taxed at the corporate level, and employees are taxed additionally at the personal level.
Tax-Favorable Characterization of Income
S-Corp shareholders are often employees of the corporation who draw a salary just like permanent non-owner employees. The owners may also receive distributions and dividends from the company. When you structure your company characterized by the distribution of salaries and dividends correctly to reduce self-employment tax liability, you'll enjoy the benefit of tax-deductible business expenses and wages.
Easy Transfer of Business Ownership
You are able to freely transfer ownership of an S corporation, which is not the case with C corporations and businesses with other business structures. For example, partnerships and LLCs that transfer more than 50 percent of the ownership interest to another person or LLC are in violation of the terms of the incorporation documents and the entity is immediately terminated. When ownership is transferred, S corporations are not required to make adjustments to property and you also are not required to follow complex accounting guidelines.
Cash Method of Accounting
Corporations have to use the accrual accounting method unless they are a small corporation. A "small company" is one with less than $5 million in gross corporate sales. S corporations, on the other hand, rarely use the accrual method unless they hold inventory.
There are many benefits of S-Corps. To take full advantage of these benefits, you need to work with an experienced attorney or CPA. If you need help with benefits of your S-Corp, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.