When researching S-corporations for dummies, it is important to know how this type of corporation works and the steps to take. Every S-corporation starts out as a regular corporation. S-corporations are only formed when normal corporations elect a specific small-business tax status through the IRS. This can be done when a business files Form 2553 a few months before the corporation forms.

S-Corporation Taxes

An S-corporation has pass-through tax status. Similar to partnership taxation or sole proprietorship taxation, the expenses and revenue of the company will pass through to the tax returns of the shareholders. S-corporations are required to file their own tax return due to their status. That said, the company still needs to issue K-1s out to the shareholders, similar to a partnership. Small businesses may prefer to be taxed as S-corporations, but before choosing this option, it's important to make sure your businesses intends to stay small for a while (about five years).

Reasonable Salary

The primary difference between the taxation of S-corporations and other entities is that the shareholders or owners can work for the business and give themselves a salary that's subjected to the same payroll taxes that are taken out from all paychecks. All profit given to the shareholders that's above a "reasonable salary" that's already been paid isn't subject to the self-employment tax of 15.3 percent.

If the company makes more than the salary a shareholder pays themselves, the savings can be huge. What is considered a "reasonable salary" according to the IRS isn't clearly defined. However, if the company ever gets audited, the IRS would ensure that the salary is similar to that of a professional in the industry with similar responsibilities.

Restrictions

If your business or LLC has chosen to be an S-corporation for its tax status, you must abide by the following rules: 

  • No more than 100 shareholders in the corporation. 
  • Shareholders can only be individual trusts, natural people, or tax-exempt non-profit organizations (excluding other entities or business structures, such as limited liability corporations). 
  • Shareholders must be resident aliens or citizens of the United States. 
  • Only one class of stock is allowed in the corporation. 
  • Insurance companies and banks can't be shareholders. 
  • Every shareholder needs to consent to the S-corporation tax designation, so a majority vote won't work.

Income Tax Restrictions

An S-corporation doesn't pay income tax, but it must set aside $2.2 million of taxable income among the owners in an equal proportion of the number of stocks that each owner has. If a shareholder has one-tenth of the total shares, $220,000 of the taxable income of the business must be included on his or her personal income tax return for the year. This must happen whether a cash distribution is received from the profit or not.

The S-corporation can distribute the cash dividends to the stockholders to allow them to have money to pay the income tax for their shares of the taxable income for the company. The primary question companies have when it comes to taxes is how to decrease the overall income tax burden on the stockholders and business entity. 

Businesses must decide if they want to be an S-corporation and pass through any taxable income to their stockholders, which will leave the stockholders with taxable income. They can also decide to be a C-corporation and have their stockholders pay another tax on dividends that they receive on top of the income tax the business pays.

Business Plan Format

A business plan is important to show to potential investors and bankers. A good business plan should include the following:

  • Nothing that surprises investors.
  • A cover page that has contact information and a statement saying the plan is confidential.
  • A table of contents so that investors can quickly find information.
  • A company description.

A marketing plan should tell readers what the plan is to reach the business' potential market, including advertising, packaging, web marketing, distribution, and more. One section should include all the members' names and what their positions and credentials are. The competition section should focus on any competitors' strengths or weaknesses. Financial projections and statements should include many different numbers, such as the income statement, financial forecasts, balance sheet, and cash flow statement.

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