S Corp Documents: Everything You Need to Know
During the growth phase, companies of any size may encounter complications during tax season. 3 min read
2. Potential Advantages of Forming an S Corp
3. Potential Disadvantages of an S Corporation
4. Tax Qualification Mistakes
5. S Corporation Requirements
During the growth phase, companies of any size may encounter complications during tax season. Therefore, considering this critical fact, opening an S corporation, also known as an S corp, may be a solution.
As a business structure, an S corp has essential tax advantages even though ownership flexibility is maintained. In 1958, Congress enacted a tax code, known as the s corp or subchapter, into the law. A significant reason an S corporation option has been established is to boost and support the creation of small, family businesses. The foundation of the S corp eliminated the double taxation for companies, which has been subjected to conventional corporations.
What Is an S Corp?
An S corporation entity acts as a regular business but with "S corporation" tax status. Double taxation, which is common for C corporations, is prevented with an S corporation. As an owner of an S corp, you have personal protection under the corporate veil. Moreover, you are not personally liable for taxes earned by the business. You are also allowed to pay tax based only on your personal income declared on tax returns.
Potential Advantages of Forming an S Corp
There are many advantages to forming an S corporation:
- S Corporations do not have to pay federal income tax with the exception of certain capital gains and passive income.
- LLCs that select S corporations for tax reasons allow profits, losses, and deductions to pass through to their shareholders. The income is eventually based on the shareholder's personal tax returns on personalized shareholder's tax rates.
- Corporate profits are taxed only once at the level of the shareholders because an S corp is a “pass-through entity.” The corporation thus successfully avoids having to pay "double taxation" of dividends.
- S corporation companies have the legal protection of personal property that is outside of the business funds.
- Shareholders are not personally liable for the company's debts. Therefore, creditors are unable to collect from shareholders for debts the business incurs.
- Owners of an S corporation can define their taxable income in a flexible way.
- Assuming you are the owner of an S corporation, you can also be an employee of the company and pay yourself a salary from the corporate income. In addition to the salary, you can also have tax-free or lower-rate dividends or distributions. This is beneficial for your self-employment tax liability if you are being reasonable with defining your salary and dividends or distributions.
- It is easy to transfer S corporation ownership interests to other owners beyond crucial tax consequences or even termination of the corporate entity.
- Transfer of the S corporation ownership does not require business modification based on property or agreements by complicated accounting rules.
Potential Disadvantages of an S Corporation
Despite the advantages to forming an S corporation, owners and shareholders may find there are some disadvantages:
- Ownership structure within S corporations is not as flexible as the structure of C corporations.
- An S corporation is limited to attract various types of investors because of the possession of only one class of stock.
- An S corporation is limited to only 100 shareholders or less. Foreign shareholders, certain trusts, or other corporate entities are not allowed to become the owners of an S corp.
- Flexibility is one of the most valuable features of an S corp because of its ability to portray earnings as wages or dividends. However, this can also be challenging because of the Internal Revenue Services' strict rules in regards to the amount of personal income you may declare. In some instances, the IRS may request the owner(s) of the S corp to readjust some of the personal income. The outcome may result in higher tax rates.
Tax Qualification Mistakes
Although this may be rare, S corp owners do make mistakes when it comes to their IRS form filing requirements connected to:
- Stock ownership
- Other elements important to consider when operating an S corp.
These inaccuracies may cause the company to lose its S corp status.
S Corporation Requirements
- It is mandatory for an S corporation to hold board of directors' and shareholder's meetings on a regular basis. Also, an S corp is required to have a leadership team.
- It is necessary to file corporate minutes and have records from these meetings prepared internally.
- Formal process and documentation are an essential part of stock transfers and related updates to company bylaws.
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