S Corporation Benefits: Everything You Need to Know
What are S corporation benefits? An S corporation is a business entity that has elected to be taxed as a flow-through entity. 3 min read
2. S Corporation Benefits
3. A Recap Of Important S Corporation Benefits
What are S corporation benefits? An S corporation is a business entity that has elected to be taxed as a flow-through entity. The 'S' relates to an IRS code section, and by choosing this, shareholders will only be taxed on their personal income tax report, one of the major S corporation benefits.
Rather than paying federal taxes, all S corporation profits and losses are passed on to the shareholders. It's at this time the taxes are calculated when the shareholders report the numbers on their tax returns. If the corporation happened to pass on any losses to the shareholder, the individual can use that amount to offset income from other sources, minimizing taxes they're paying.
How To Form An S Corporation
To create an S corporation there are Articles of Organization that need to be filed with the relevant sources. The process for creating an S corporation is like that of an LLC. You'll need directors and officers, and shareholders and owners have their personal assets protected from business liabilities.
The IRS has put in place some restrictions on which businesses can qualify to be an S corporation. They are:
- All S corporation shareholders must be either U.S. citizens or permanent residents. By extension, this means an LLC or partnership cannot be an S corporation shareholder.
- The maximum number of shareholders of an S corporation is 100, however, there is no cap on the number of management positions and their residency requirements.
If a business does not meet the above criteria they cannot be taxed as an S corporation. Even if a business meets these criteria, many miss out on becoming an S corporation due to a lack of action. The deadline to apply with the IRS to become an S Corp for new businesses is 75 days from when you incorporate to the day of filing IRS Form 2553.
S Corporation Benefits
S corporation shareholders are allowed to be regular salary withdrawing employees of the business. In addition to a regular salary, they receive tax-free dividends and other distributions as a shareholder. If shareholders want to transfer their ownership to another shareholder, they can without any tax consequences resulting.
If an S corporation wants to transition to a C corporation, this is easier than if it were an LLC. An S corporation is a federal tax election, therefore there would be no paperwork required to terminate the S corporation business entity. If the business was an LLC it would need to take a more formal approach including filing lot of paperwork required if they do business in multiple states.
Establishing a business with credibility isn't easy. An S corporation gets a boost in the eyes of potential customers, employees, vendors, and partners as an S corporation takes a formal commitment that an LLC incorporator might not do.
Corporations must follow the accrual accounting method with a few exceptions. An S corporation benefits from the ability to use the simple accounting method, with the accrual method only required if they have inventory. For most S corporations, such as consultants, inventory is not a factor.
Consultants are a good example of an S corporation set up. This is because they have minimal start-up costs with no large equipment expenses necessary to start working. Going forward, they charge a high amount of money that is significantly more than similar lesser qualified services without a major change in effort or expenses.
A Recap Of Important S Corporation Benefits
- S corporations avoid double taxation. Income is only taxed at an individual level, not a corporate level.
- By choosing to incorporate as an S corporation, you're sending an indicator you're a serious business to potential customers.
- S corporations aren't required to use the accrual accounting method.
- The personal assets of shareholders are protected from business liabilities.
- If you want to change your business type in the long run, terminating an S corporation is relatively straightforward
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