S Corporate Structure: Everything You Need to Know
The S corporate structure is a type of corporation. Generally, there are C and S corporations. 4 min read
2. S Corp Requirements
3. S Corp Advantages
S Corporate Structure
The S corporate structure is a type of corporation. Generally, there are C and S corporations. The S corporation is a specific version of the C corporation. It is formed in the same way as the C corporation by filing the Articles of Incorporation with the Secretary of State. The S corporation is treated as a pass-through tax entity that doesn’t pay corporate income taxes. In order to elect tax status as an S corporation, the business must submit a form on the Internal Revenue Service (IRS) website. Keep in mind that a corporation or Limited Liability Company (LLC) can be treated as an S corporation for tax purposes.
S Corp Requirements
When you initially form your corporation or LLC, it will automatically be treated as a C corporation or LLC. In order to elect status as an S corporation, you will need to meet the requirements in order to do so. Therefore, before submitting the form for such election on the IRS website, you’ll want to first confirm that you can do so.
Such requirements include the following:
- The business must first be eligible to be taxed as an S corporation, i.e. corporation or LLC
- The business can’t have more than 100 shareholders or members
- Such shareholders or members must be individuals, estates, exempt businesses, or certain trusts
- The shareholders can’t be other corporations, partnerships, or LLCs
- The shareholders cannot be nonresident citizens or aliens
- The S corporation can have only one class of stock
- The S corporation cannot operate as a financial institution, insurance company, or domestic sales corporation
- The business’s tax year must end on December 31
- All of the shareholders must agree to operate as an S corporation
S Corp Advantages
There are several advantages to operating an S corporation. While some companies might not fare well operating as an S corporation, smaller business owners who meet all of the above-mentioned requirements will significantly benefit from the many advantages that the S corporation offers, which include:
- Liability protection
- Pass-through taxation
- Perpetual existence
- Annual tax requirement as opposed to quarterly tax requirements
- Shareholder compensation
- Ease of ownership transfer
- Cash method of accounting
Similar to other business structures, including the C corporation and LLC, the S corporation provided liability protection for the owners and shareholders. This will ultimately protect their personal assets in the event that creditors bring a legal suit against the business for outstanding debt. Keep in mind that some exceptions exist to this rule. For example, if the shareholder or owner engages in fraudulent or illegal conduct, personally guarantees a loan, or holds the business out as his own, then the creditor or plaintiff might be able to pierce the corporate veil and hold the shareholder or owner personally liable.
The S corporation operates as a pass-through tax entity, similar to that of an LLC. The business profits and losses will pass through to the shareholders who will report it on their individual tax returns. Unlike the S corporation, the C corporation incurs double taxation, once at the corporate level and again at the personal level.
The S corporation, similar to that of a corporation, has a perpetual existence. Therefore, if a member becomes incapacitated, quits, or dies, the business will continue operating. This can be especially helpful for an LLC choosing to operate as an S corp for tax purposes, since LLCs don’t have a perpetual existence.
The S corporation has an annual tax-filing requirement, at which point the shareholders are taxed. However, a C corporation must pay taxes on a quarterly basis.
The S corporation shareholders can operate as employees of the corporation and pay themselves a reasonable salary for their work. But be mindful that the compensation must be reasonable and cannot be too low to simply reduce tax implications.
The S corporation also offers ease when transferring ownership. Shares can be easily transferred to someone else. However, an LLC membership transfer can be much more difficult and might even trigger dissolution of the LLC. Furthermore, S corporation doesn’t have to make any adjustments to its property basis or comply with complex accounting rules when shares are transferred.
The S corporation can use the cash method of accounting whereas C corporations must use the accrual method. The only requirement here is that the S corporation has gross receipts of no more than $5 million. Additionally, the only time that the S corporation would have to use the accrual method is if it has inventory.
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