S Corp Liability: Everything You Need to Know
S Corp liability protections are popular among many small business owners because it uses a pass-through taxation which is the same tax method seen in LLCs.3 min read
S Corp liability protections are popular among many small business owners. An S Corp uses pass-through taxation, the same tax method seen in LLCs. Pass-through taxation refers to income and losses that flow from the business to individuals, where they can file such information on their personal tax returns. The “S” pertains to a code the IRS uses to designate such a corporation. The classification allows individuals to be taxed at an individual level, as opposed to individual and corporate taxation seen in C Corporations. C Corps are taxed at the business and individual levels, otherwise known as double taxation.
In addition, you do not have to pay federal income taxes under an S classification. Many business owners choose S Corps due to its single taxation and limited liability protections, and certain states provide additional benefits.
S Corps advantages outweigh the disadvantages in the following ways:
- Asset Protections: S Corps protect the personal assets of all shareholders. With the exception of express personal guarantees, shareholders are not responsible for liability or debts incurred from the business. Additionally, creditors cannot petition for personal assets in the form of bank accounts or houses. This is not the case with general partnerships or sole proprietorships.
- Special Tax Benefits: S Corp owners can also classify themselves as employees to gain additional tax savings, and they can still receive dividends. Such a strategy can reduce the amount of self-employment taxes owners would need to pay, and they can deduct wages-paid and business-expenses from their tax returns.
Moreover, S Corps allow owners to transfer shares without burdensome regulations, and they can be transferred freely without tax penalties. This is not the case with LLCs, as transfers of over 50 percent would result in entity termination. The S Corp also does not need to adjust property basis or adhere to complex accounting rules when a transfer ownership occurs.
When it comes to accounting, corporations may use the accrual method, unless they are smaller corporations. For instance, a small corporation would have gross receipts amounting to $5,000,000 or less. With that, S Corps do not have to apply the accrual method unless inventory is involved.
Credibility with the Public
Aside from tax and accounting benefits, S Corps gain additional credibility among vendors, clients, customers, and partners. S Corps reveal that all owners involved are committed to the business, and that the business itself is legitimate. Such credibility may also attract additional business and potential partners who wish to associate with your corporation.
Tailored for Certain Businesses
S Corps are excellent options for certain businesses:
- Businesses that have do not have considerable start-up capital
- Businesses that do not need to purchase major equipment before commencing operations
- Businesses that will make a large amount money without extensive expenses and efforts
S Corps are also great for certain professions, such as consultants. In essence, any business that provides a service can benefit from an S Corp classification.
To start an S Corp, you should first file what’s called an Articles of Incorporation in the state where the corporation will exist. Further, you need to appoint a registered agent, which is a person that will accept documents on behalf of your business. From there, you need to pay the appropriate fees to register the corporation. Depending on the state, you may also need to pay ongoing fees in the form of annual reports or franchise taxes. Such fees are not expensive, but they are expenses that a sole proprietorship or general partnership would not have to pay.
When it comes to tax obligations, it can be very easy to make certain mistakes in areas pertaining to:
- Stock ownership
- Filing mandates
Such mistakes could result in termination of the corporation, which is why you should conduct extensive research regarding the filing process and maintenance requests you need to adhere to. Although mistakes do not often result in outright termination, and can be remedied by fixing mistakes, termination is a possibility.
S Corp Drawbacks
You should be aware of certain restrictions. For instance, S Corps only come with one form of stock, but it can have voting and non-voting shares. This can be a disadvantage if you want investors to have different stock classes. Additionally, S Corps cannot have more than 100 shareholders. Also, foreigners cannot own a piece of an S Corp, including other entities and certain trusts. Finally, the IRS places additional scrutiny on S Corps to ensure all records match the reality.
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