Examples of S corporations are businesses that prefer to pass their income, deductions, losses, and credit through shareholders for the benefit of limited liability and to avoid double taxation.

The IRS states that in general, S corporations are excused from federal income tax, but not tax on specific capital gains and passive income. They are appealing in that they function like a partnership, allowing for taxes to be paid only at the individual income tax level. A regular corporation is subject to being taxed on both the corporate and individual income tax levels.

Tax laws vary according to different municipalities and states, so some advantages may not apply.

For example, New York City's corporate income tax is 8.85 percent. However, if that business is able to prove that it also operates outside of the city, that portion may be excused. In California, a similar tax levy is applied as franchise tax, at a minimum of $800, or 1.5 percent on net income.

Benefits to Becoming an S Corporation

  • Using an S corporation layout can decrease the self-employment tax. The taxable business income is able to be divided into two parts, which are distribution and salary. The salary part solely draws the self-employment tax, reducing tax liability. (Note, any unreasonable split of distribution and salary could be considered an attempt to avoid taxes so it is appropriate to draw about 60 percent of the company's profit as salary. If the IRS observes a high-distribution to low-salary, it makes changes accordingly, adjusting the salary to a larger sum which can cause unexpected higher taxes.)
  • Shareholders personal assets are also protected by the arrangement of an S corporation as shareholders cannot be held responsible personally for the debts and liabilities of the business.
  • Since an S corporation is recognized as a business structure, it is held in high esteem among partners, customers, and potential vendors.
  • An S corporation has a separate life span, so is not tied to the owner's life or departure from the business, making it easier to conduct business and consider growth and long term aims.

Qualifiers for Becoming an S Corporation

The IRS enforces many qualifiers for the S corporation status which limit the type and number of shareholders. In order to qualify for S corporation status, it is recommended by the IRS that the corporation first meet the following requirements:

  • Be located in the United States.
  • Have only estates, individuals, and certain trusts as shareholders. Corporations, partnerships, or non-resident shareholders are not included in this.
  • Have less than 100 shareholders.
  • Own one kind of stock.
  • Not have corporations, non-citizen shareholders, or partnerships.
  • Not be a corporation denied an S corporation structure, such as particular financial institutions and insurance companies.

Steps to Becoming an S Corporation

  • First being considered as a corporation. This can be achieved through filling in and submitting documents such as a Certificate of Incorporation or the Articles of Incorporation to the right government authority, with the required fee. 
  • After the incorporation actions are finished, a Form 2553 must be signed and submitted by shareholders. 
  • Once given the title of an S corporation, taxes are managed by the corporation's members on their own returns.

The IRS enforces many qualifiers for the S corporation status which limit the type and number of shareholders.

Protocols For an S Corporation to Follow

  • Regularly scheduled meetings of both shareholders and directors.
  • Records of meetings kept.
  • Record of official bylaws.
  • Maintenance of formal records and other recordkeeping expectations.
  • S corporations require bookkeeping and accounting, meaning the help of an informed accountant is needed, increasing the costs. Also, there might be more legal advice required for business loans, more banking, taxation, and other concerns.

Two Ways to Sell an S Corporation

  1. A direct sale, in which the buyer purchases the corporation outright and transfer of ownership is immediate.
  2. A sale that happens gradually over a course of time. Either way the sale happens, ownership is transferred via a written sales agreement, formalizing the entire process.

S corporations can be a valuable business structure for individuals and businesses for taxation purposes and others. As long as one familiarizes themselves with the qualifications considered by the IRS to be incorporated as an S corporation and the particular tax laws set out by different states and municipalities. 

For more information concerning S corporations, 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.