File S Corp: Everything You Need to Know
Corporations that wish to file S corp status need to make sure they qualify and then complete additional paperwork. 3 min read
2. Pros and Cons of S Corp Status
3. S Corporation Taxation
4. Penalties for Late Filing
Corporations that wish to file S corp status need to make sure they qualify and then complete additional paperwork. Any business that incorporates is automatically classified as a C corporation in the eyes of the IRS.
Some smaller companies elect to file for S corporation status, which allows them to keep the important liability protections afforded standard corporations, but with some tax-related benefits. The S corporation status was created to help grow smaller and family-owned businesses while offering them protection from the double taxation that traditional corporations are subject to.
Even though income is passed along to shareholders for tax purposes, S corporations must file an informational income tax return, along with other mandated IRS forms.
How to File an S Corp
To form an S corporation, follow the steps for creating a traditional corporation. Once you decide on a physical business location, complete these steps:
- Check to verify the business name you want is available; if you want a name that differs from your legal name, you'll also need to file a DBA (doing business as), a fictitious business name
- Prepare and file Articles of Incorporation with the Secretary of State
- Complete corporate bylaws that outline operations, officer positions, duties, and company rules; all board and shareholder meetings require minutes
- Apply for an Employer Identification Number (EIN)
- Verify that you have all state and local permits as required
- Double check that you qualify for S corporation status
- You must offer only one class of stock
- You must cap shareholders at 100 and everyone must agree to S corporation status
- Ensure all shareholders are eligible — individuals, certain trusts, and estates; you cannot have non-residents, corporations, or partnerships
- Determine what your tax year status will be
- File IRS Form 2553 to form the S corporation
Once it's approved, your new tax status applies until you revoke or terminate it.
Pros and Cons of S Corp Status
Outside of the noted tax advantages, there are other benefits to being classified as an S corporation:
- Protection of assets
- Flexibility on how income is characterized
- Option to pay dividends in addition to a salary
- Easy ownership transfer
C corporations have greater flexibility when it comes to ownership structure than S corporations. While the benefit of flexibility in categorizing income as dividends or wages is ideal with S corporations, the IRS is always on the watch for businesses who don't accurately pay wages in an attempt to avoid self-employment taxes.
Sometimes S corporations make a mistake when it comes to their IRS form filing requirements — consent, notification, stock ownership, etc. — which can cause a company to lose its status.
S Corporation Taxation
With conventional corporations, businesses are treated as separate entities regarding taxes and they are taxed on all business earnings. This is where the "double taxation" issue comes into play, as a corporation pays taxes and shareholders also pay taxes on profits as dividends. Double taxation essentially means both the business and shareholders are taxed on the same income.
S corporations don't pay any direct taxes and are treated more like a partnership wherein income and deductions are transferred, or passed through, to the shareholders who are responsible for filing individual tax returns.
Despite not paying income tax, they still are required to file annual tax returns with IRS Form 1120S. It's primarily for informational use, but it does give the IRS a picture of how the business is operating and what its earnings and expenditures are.
For S corporations who pay wages to employees, the corporation is required to withhold federal income taxes, Social Security, and Medicare taxes. Every quarter, the company must also file IRS Form 941 which details the total amount withheld, which must be remitted to the IRS.
Penalties for Late Filing
S corporations are required to file IRS Form 1120S by a specified due date, or the IRS will issue a penalty. The penalty is a minimum of $195 for every month, or portion thereof, which is then multiplied by how many shareholders the S corporation has.
If an S corporation misses the deadline for Form 941 and there is an unpaid tax balance, the IRS may assess a five percent penalty on the remaining balance for every month or portion of the month it's late, up to 25 percent maximum.
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