Start an S Corp: Everything You Need to Know
Find out everything you need to know about how and why to start an S corporation company.3 min read
2. Advantages of an S Corporation
3. Eligibility Requirements of an S Corporation
4. Guide to Creating an S Corporation
Start an S corp to receive the benefits of a corporate structure without the double taxation that exists in a traditional C corporation. Find out everything you need to know about how and why to start an S corporation company.
What is an S Corporation?
S corporations are not a new concept. With the introduction of limited liability companies (LLCs), S corporations became less common. However, S corps are a good choice for many companies because they allow them to benefit from payroll tax savings.
To become an S corp, a company must elect a special tax status with the Internal Revenue Service (IRS). LLCs can make the same election. Like C corporations, S corporations provide limited liability benefits to shareholders. As such, shareholders are not personally responsible for the company's liabilities and debts.
However, S corps have the added advantage of being pass-through entities for taxation purposes. This means S corps do not pay federal taxes at the corporate level. Instead, shareholders report the corporation's income and losses on their personal tax returns. Any profits are taxed at the individual rate and paid by the shareholder instead of the corporation.
Advantages of an S Corporation
In addition to liability protection and avoiding double taxation, there are many other reasons to start an S corp. They include the ability to:
- Easily transfer ownership or raise capital by selling stock
- Continue to exist even if the owner dies or suffers a disabling illness
- Gain more credibility as a legitimate professional business than as a general partnership or sole proprietorship
- Allocate profits, losses, and other pass-through items relative to each shareholder's stocks
- Reduce the risk of an audit compared to sole proprietorships
- Claim tax-deductible business expenses
- Provide self-employment tax savings to shareholders who are classified as employees
Eligibility Requirements of an S Corporation
In order to start an S corp, your company needs to meet certain eligibility requirements. They include:
- Having fewer than 100 shareholders who are all U.S. citizens or permanent residents
- Making sure all shareholders consent to the S corp election
- Ensuring all shareholders are individuals or certain types of trusts and estates instead of partnerships or corporations
- Having only one class of stock
For your company to meet the S corp eligibility requirements, it must not perform some types of business. For example, you cannot provide insurance or certain financial services. In addition, your company cannot elect an S status if it falls into any of the following types of business:
- A bank or thrift company that uses the reserve accounting method for bad debts under Section 585 of the tax code
- An insurance company that pays taxes under tax code subchapter L
- A possession corporation under Section 936 of the tax code
- A domestic international sales corporation (DISC) either currently or in the past
Failing to meet any of these S corp requirements at any time will result in the loss of your S status. Your company will revert to a traditional C status. If your existing corporation does not meet these requirements, you will need to restructure before you can apply for S status.
Guide to Creating an S Corporation
Before you can start an S corp, you must incorporate your business. The first step to becoming a corporation is deciding which state you want to incorporate in. You need to think about your own personal location as well as the location of the people you plan to hire. You should also consider where you plan to keep your bank accounts and in which states you will be accepting orders.
Next, you need to give your business a name. To find out if the name you want is available in your state, do a search on the local secretary of state's website. Businesses that already have a name will add “Inc.” or “Incorporated” to the end of their name once they form a corporation. If the name you want to use for your business is not your real name, you need to file a fictitious business name with your county.
There are many great reasons to start an S corp company. Knowing the advantages to electing an S status can help you make the best choice for your business.
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