S Corporation Business: Everything You Need to Know
An S corporation business is sometimes referred to as a "lite version" of a C corporation.3 min read
2. Potential Disadvantages of S Corporations
3. Tips for Setting up an S Corporation
4. Similarities Between LLCs and S Corporations
5. Differences Between LLCs and S Corporations
An S corporation business is sometimes referred to as a "lite version" of a C corporation. S corporations offer perpetual existence, protection of limited liability, and investment opportunities. This type of business files taxes through a special election of Subchapter S of the Internal Revenue Code.
S corporations offer a variety of benefits and advantages:
- Limited liability for officers, company directors, shareholders, and employees.
- Taxed as a pass-through entity where shareholders report profits and losses on their own individual tax returns.
- Lack of double taxation as commonly seen with C corporations.
- S corporations can attract some investors through stock offerings.
- S corporations have perpetual existence, so they exist even if an owner leaves or passes away.
- They only file taxes once a year, whereas C corporations must file quarterly.
- It is easy to transfer stock in S corporations, whereas LLC ownership is not easily transferable.
- S corporations can have an advantage over LLCs when it comes to reducing liability for self-employment taxes.
- S corporations have good privacy protections, especially in states such as Wyoming and Nevada.
Potential Disadvantages of S Corporations
S corporations also have a number of potential disadvantages:
- They cannot have more than 100 shareholders.
- Ongoing expenses and formation costs are high (when compared to sole proprietorships and partnerships).
- They can only offer one type of stock.
- Shareholder eligibility is more restrictive than with C corporations.
- Owner-employees with more than 2 percent of shares cannot receive tax-free benefits.
- High-income shareholders will pay more taxes on the pass-through income distributions.
- S corporations are not intended for holding appreciating investments, as capital gains are higher than with LLPs and LLCs.
The IRS pays close attention to S corporations to make sure they aren't trying to eliminate all tax liability by not paying employee shareholders proper salaries. If you violate any rules, the IRS will revoke your S corporation status, and you might have to pay a couple of years' back taxes. Make sure you don't accidentally cause your S corporation status to get revoked.
Tips for Setting up an S Corporation
Many businesses choose to incorporate in the state where they primarily do business. They can also incorporate in Delaware to gain access to the state's business-friendly laws. You will typically encounter fewer complications if you incorporate in your home state, where you won't have to file annual reports or pay franchise tax. Other things to keep in mind when forming an S corporation include:
- You must file IRS Form 2553 to be considered for S corporation status.
- Costs of setting up an S corporation are similar to those for C corporations, LLCs, etc.
- Each corporation is different and brings its own unique challenges.
- Most states require S corporations to pay annual taxes. Failure to pay can result in fines and even the inability to conduct business.
- An S corporation can own an LLC; however, only single-member LLCs can be S corporation owners.
- You can "pierce the corporate veil" and become personally liable if the S corporation gets terminated for failing to pay fees or file required forms.
Similarities Between LLCs and S Corporations
- Both LLCs and S corporations offer some limited liability protection.
- They are both separate entities created through a state filing.
- Both offer pass-through taxation benefits.
- Business profits are paid on shareholders' personal returns.
- Both have similar state requirements regarding processes such as filing annual reports.
Differences Between LLCs and S Corporations
S corporations have lower self-employment taxes than do LLCs because the owners can be treated as employees who receive reasonable salaries. S corporation earnings after salary payments can be treated as unearned income that's not subject to self-employment taxes. Other differences include:
- The IRS restricts ownership status with S corporations, but not with LLCs.
- S corporations have more formal requirements than LLCs, which simply have recommended guidelines.
- LLC owners can choose between manager-managed or member-managed structures. A member-managed LLC is more like a partnership. A manager-managed LLC is more like a corporation.
- S corporations have officers and directors, while LLCs don't.
- S corporations are perpetual, whereas some states require LLCs to dissolve if a member dies or leaves.
If you need help setting up an S corporation business, you can post your legal need on UpCounsel's marketplace. UpCounsel only accepts the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.