S Corp Form: Everything You Need to Know
An S Corp form is the document you’ll need to turn your corporate entity into an S tax classification.3 min read
2. Tax Breakdown
3. Ownership Transfer
4. S Corp Restrictions
An S Corp form is the document you’ll need to turn your corporate entity into an S tax classification. Expanding firms face many complexities when tax season arrives, which is why you should consider an S classification as your company begins growing.
An S Corp is a business classification that ensures your company remains separate from yourself and other members. It is an entity that provides important tax advantages and still preserves flexibility in terms of ownership.
An S Corp is also called a subchapter of a small corporation, and Congress created the tax code in 1958. The S Corp was designed to support smaller businesses and eliminate double taxation from the corporate structure. In essence, an S Corp is simply a corporate entity with an S classification.
S Corp Benefits
Such a classification provides certain benefits in the form of:
- Tax Advantages: S Corps do not have to pay federal income taxes, with the exception of passive income and capital gains income. An S classification permits pass-through taxation, where income flows from the business to shareholders. From there, they file such income on their personal tax returns and pay their taxes accordingly. Because of the pass-through method, members are only taxed once, and the business itself is not taxed. This also prevents double taxation.
- Liability Protection: S Corps provide the same level of liability protections as a standard corporation. Because S Corps are still corporations, they retain the same protection levels seen with a traditional corporate structure, protecting owners from lawsuits, debts, and liabilities that the corporation accumulates. With that, corporate entities do not offer absolute protections, and such protections can be removed if shareholders guarantee loans, or if members commit infractions that associate other members and the business.
- Flexible Income Characterization: Becoming an S Corp gives you certain flexibilities not seen in other business entities. If you are an owner, for instance, you may classify yourself as an employee and give yourself a salary. Also, you may pay dividends to yourself, including tax-free distributions. Such a method helps you lower your self-employment tax obligations, so long as you are assessing your dividends/distributions and salary in a reasonable manner.
It should be noted that the IRS does not wish to see yourself working on an artificially low salary to avoid paying self-employment taxes on the distribution/dividend sections of your income stream.
Sole proprietorships and general partners need to pay self-employment taxes in the form of Medicare and Social Security taxes. With an S Corp, such profits are lowered by the balance paid to owners classified as employees, lowering the overall self-employment tax bill. For instance, a sole proprietorship that makes $100,000 in profit needs to pay $15,300 in self-employment taxes.
On the other hand, an S Corp that pays a $50,000-wage to employees/owners allows the owner to cut that self-employment tax bill in half. In addition, the business needs to pay half of the FICA taxes (Medicare/Social Security) on behalf of the employees.
An S Corp allows members to transfer ownership freely without burdensome regulations or tax consequences. In addition, ownership transfers do not terminate corporate entities, as would be the case with LLCs. Moreover, S Corps have parameters in place in the event of losses. For example, if an S Corp incurs a loss, each owner’s share from the loss is passed to his or her individual tax return. If the owner has additional income, such a loss can lower a portion or all of the income.
S Corp Restrictions
S Corps provide many benefits, but it also comes with certain restrictions:
- Dividends and Wages: When it comes to income, the IRS scrutinizes corporations due to the potential for abuse. The IRS may ask you to reclassify your income, which may force you to pay higher taxes.
- Tax Mistakes: S Corp owners tend to make mistakes regarding IRS form mandates pertaining to election, consent, notification, and stock ownership. Although rare, such mistakes could cause members to lose their S classification.
In addition, S Corps must adhere to the following mandates:
- S Corps can have no more than 100 shareholders.
- S Corps are permitted one class of stock (no tiered stockholders allowed).
- Non-residents cannot own an S Corp.
- Corporations and partnerships cannot own an S Corp.
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