IRS S Corp Status: Everything You Need to Know
IRS S-corp status is a business structure that is granted to give a company a legal identity as a corporation. It also gives the owners protection from personal responsibility for the debts and liabilities of the business. 3 min read
2. Tax Benefits
3. Management Flexibility
4. When an S-Corp Is Not the Best Choice
5. How to Achieve S-Corp Status With the IRS
IRS S-corp status is a business structure that is granted to give a company a legal identity as a corporation. It also gives the owners protection from personal responsibility for the debts and liabilities of the business. For example, if the business is sued, the owners' personal assets can't be attached. The S-corp status also lets the owners avoid double taxation since the profits of an S-corp are only taxed once, at the individual level. Sometimes known as an S-corp or a small business corporation, these companies are typically family businesses or other small companies. The laws related to IRS S-corp status were enacted in 1958 by congressional action.
Why Choose S-Corp Status?
The S-corp may be ideal if you have a domestic company and no plans to seek investors from outside the United States. This form of organization is more streamlined and less cumbersome to operate than a C-corp.
Because it is a pass-through entity, the S-corp status offers significant tax benefits over the traditional corporate status. Unlike the C-corp, the S-corp does not have to pay income taxes, so this status is generally better for the owners of the company. Also, it doesn't restrict the owners' flexibility to run the company as they choose, within the law, of course.
- The owners of an S-corp can be paid as employees. Their salary, wages, and bonuses reduce the business profits. This lowers self-employment payroll taxes as compared to other forms of business, like an LLC.
- If the company has a loss, each owner takes a share of that loss and passes it on to his or her personal tax return. If the owner has other taxable income, that loss can reduce the individual's tax bill.
- Since an S-corp's profits are taxed at the individual owner's rate, the tax bill may be less than the typical 35 percent corporate tax rate, depending on the owner's tax bracket. Profits allocated to each owner are not subject to the self-employment tax, which results in further savings.
- Similar to an LLC, an S-corp has no federal income tax liability in and of itself, unless there are certain capital gains or passive income. Income tax obligations flow to the individual owners.
- Dividends and distributions to an owner from the S-corp are usually taxed at a lower rate than the compensation he or she receives as an employee of the business. As long as the arrangement is reasonable for the marketplace, this can lower the owner's self-employment tax liability. Owners must be aware that unreasonable calculations can trigger the IRS to require you to reclassify your income and potentially pay higher taxes.
With an S-corp, shares of ownership are transferable. Owners can sell their interest in the company without having to get the agreement of the other owners, which they would have to secure if the business was an LLC. The sale of ownership doesn't create tax issues or impact the corporate identity. The property basis doesn't have to be adjusted, and there are no complicated accounting rules.
When an S-Corp Is Not the Best Choice
In some circumstances, you may want to choose another structure other than the S-corp for your business. The C-corp is probably a better option if your future goals include becoming a publicly traded company or bringing in overseas investors. The C-corp can offer more types of stock and have foreign shareholders.
How to Achieve S-Corp Status With the IRS
Form 2553, Election by a Small Business Corporation, tells the IRS what it needs to know about how your business operates so it can determine eligibility. In order to qualify, the company must:
- be a United States company with no foreign investors.
- be an eligible corporation. Some financial institutions, insurance companies, and domestic international sales corporations are ineligible for S-corp status with the IRS.
- have a maximum of 100 allowable shareholders (some trusts, individuals, and estates but not nonresident alien shareholders, partnerships, or corporations).
- offer only one type of stock.
- have a business year that ends on Dec. 31.
Businesses that don't maintain eligibility or those that make mistakes on filing documents may lose the S-corp status. Errors related to stock ownership, election, consent, and notification are common.
If you need help with getting IRS S-corp status, 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.