S Corporation Meaning: Everything You Need to Know
When determining S corporation meaning, it's important to know that an S corporation pays no income tax and is designed for small businesses. 3 min read
When determining S corporation meaning, it's important to know that an S corporation pays no income tax and is designed for small businesses. This corporation was formerly called a subsection S corporation.
An S corporation allows its partners to have limited liability protection in addition to direct flow-through of losses and profits. It's often more appealing to small business owners than a standard (or C) corporation. An S corporation has certain tax benefits and the same liability protection as a corporation.
A subchapter S (S corporation) is a corporation that fulfills certain Internal Revenue Code requirements. It has a maximum of 100 shareholders and gives them the benefit of incorporating while filing taxes as a partnership. These shareholders include only:
- Tax-exempt charitable organizations.
- Specific trusts and partnerships.
- Other S corporations.
S corporation owners who lack inventory can use the cash method of accounting, which records taxable income and deductible expenses paid in cash. You can avoid double taxation by passing income directly to shareholders. The corporation files an information return at the end of the year. This return includes:
- All shareholders' share information pertaining to their percentage of stock ownership.
Conversely, a corporation must make the subchapter S election before two months and 15 days after the first day of the taxable year. The election requires shareholder consent. However, some states treat S corporations differently. Certain states don't offer tax breaks, and others require S corporations to file a state-specific form. Check with an attorney in your state to determine your qualifications.
Advantages of Filing Under Subchapter S
There are several benefits to filing under subchapter S. Because it highlights the owner's commitment to the company, S corporations offer businesses a way to create credibility with suppliers, investors, employees, and potential customers. Shareholders can be employees of the company as well as receive salaries, dividends, and other tax-free distributions. This disbursement might help the owner lower his or her self-employment tax while spurning deductions for wages.
In addition, S corporations don't pay federal taxes at the entity's level, which is extremely helpful for newly established businesses. They can also transfer interests without facing tax penalties.
Disadvantages of Filing Under Subchapter S
There are also some downsides to filing under subchapter S. The Internal Revenue Service (IRS) examines shareholder salaries or dividends payments to make sure they're accurate and realistic. If the wages are dividends, the business loses a deduction for compensation paid and must pay more in employment taxes. Also, if there are mistakes in election, notification, consent, or stock ownership requirements, the S corporation might be terminated.
Filing under subchapter S costs time and money. The owner files for incorporation with the Secretary of State, secures a registered agent, and pays appropriate fees. Some states make owners pay an annual report fee or franchise tax. S corporations must also hold shareholder and director meetings, keep minutes, and let shareholders vote on major corporate decisions.
Requirements of S Corporations
To obtain S corporation status, the business must adhere to a few guidelines:
- Be a domestic corporate or domestic entity.
- Have at most 100 shareholders. All shareholders must be U.S. citizens and resident aliens. They also must consent to the S corporation election.
- Offer only one class of stock.
- Not be a bank or thrift institution, insurance company, corporation elected as a possessions corporation under section 936, or domestic international sales corporation (DISC).
- Adhere to tax guidelines. It must adopt one of the following tax years: ending on December 31, a natural business year, an ownership tax year, a tax year elected under section 444, or a 52-53-week tax year.
- File IRS Form 2553 in a timely manner. The S corporation must do this before the end of the 15th day in the third month of the tax year. If it fails to do so, it must see Rev. Proc. 2004-48, 2004-32, I.R.B. 172.
An S corporation might have its subchapter S status revoked if it does not file with the IRS on time or fails to meet the above eligibility conditions. If subchapter S status is revoked, the business is taxed as a corporation.
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