S Corp Benefits: Everything You Need to Know
S corp benefits must be taken into account by all business owners when considering how to best structure their businesses for continued growth and success. 3 min read
S corp benefits must be taken into account by all business owners when considering how to best structure their businesses for continued growth and success.
What Is an S Corp?
An S corporation is a small corporation that has chosen to file taxes under Subchapter S of the IRS code, which allows it to receive a few tax advantages akin to a partnership. Due to LLC being a suitable option for business owners in most cases, S corps are not that common today. However, their original purpose was to combine two different forms of small domestic corporations:
- A corporate structure that is taxed on two levels, but no members have liability
- A partnership form where at least one member had complete exposure and obligation to business debts
Principal S Corp Taxation and Liability Benefits
When considering the advantages possible for the owners of an S corp, you may see that what is beneficial in one regard can be a disadvantage in another. One example is Subchapter S corporation's "pass-through" structure, which is an entity feature that S corps share with LLCs. In more ways than not, pass-through taxation is a positive thing. However, when considering possible expansion and getting money to fund building of new locations, for example, a regular corporation might be a better choice than an S corp because profits can remain inside the company.
Limited liability is another benefit that S corps share with C corps and LLCs. With this protection, personal property of the company's owners is separate from the claims of litigation or contracts of business creditors.
Regarding the S corporation's pass-through tax structure, a great benefit for business owners of this type of entity as well as LLC's is that all income from the business, including losses, credits, and a lot of tax deductions, is not taxed at the corporate level. Instead, it all passes through to the owners. Another benefit is the impossibility of double taxation, which can happen when dividend income gets taxed at the shareholder and corporate level.
Significance of Salaries and Dividends
The S corp allows owners to get dividend and salary payments right from the corporation. This means that the tax bill on everything gets reduced because there is no self-employment tax on dividends. Additionally, the company can subtract the amount spent on wages when totaling how much income passes through to the shareholders. The Internal Revenue Service pays close attention to how a corporation characterizes salary and dividends to make sure the payments are "reasonable." If the IRS finds that the distribution is unreasonable, it will go ahead and re-characterize the income.
Can You Change an S Status Into a C Status?
It is much easier to convert an S corp into a C corp than changing an LLC into a C corporation. The only thing required for an S corp is to change its federal tax election because that's what determines the S corporation status in the first place. The owner may terminate the election without filing any paperwork with the Secretary of State. An LLC converting to a C corp status has to file the documents with the Secretary of State. A formal change must be made not only in the state of formation, but also everywhere it is allowed to conduct business.
Which Is Better: LLC or S Corp?
Deciding which of the two business structures is a better choice gets debated by many people. To decide on an S corporation or LLC, you must compare the advantages and disadvantages each one offers for your business. Your decision must be based on:
- The type of business you own
- Long-term and short-term goals you have for your business
- Plans for the company
If you prefer a structure that allows salary and dividend payments and has pass-through taxation, an S corp is your best choice. If you make this election, make sure you meet all the requirements and can maintain the compliance in order to preserve the status. Corporations are subject to extensive formalities that LLCs are not burdened with. Unlike LLCs, corporations have no flexibility.
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