Sub Chapter S Corp: Everything You Need to Know
The Subchapter S Corp is an attractive business setup for small business owners. 4 min read
2. Time Period to Elect S Corp Status
3. Revocation of S Corp Status
4. S Corp vs. LLC
5. S Corp Form 1120-S
Subchapter S Corp
The Subchapter S Corp is an attractive business setup for small business owners. In order to operate as an S Corp, the business must meet certain requirements that are set forth by the Internal Revenue Service (IRS).
Some key features of the Subchapter S Corp include the following:
• Ownership restriction
• Pass-through tax status
• One class of stock
• Eligibility for shareholders
• Flexibility in accounting method
There is a restriction on ownership, as there can be no more than 100 shareholders. Furthermore, the S Corp operates as a pass-through tax entity, so all shareholders will report the profits/losses of the business on their personal tax returns. Because of this, the company avoids double-taxation, as the business doesn’t file corporate income tax.
The S Corp can only offer one class of stock. The shareholders in the S Corp must be eligible to operate as shareholders in the business; this means that the shareholder must be an individual, trust, or estate. The shareholder cannot be another business. Additionally, the shareholder must be a U.S. citizen or permanent resident of the country. Banks and insurance companies cannot elect to be taxed as S Corps and can only operate as a C Corporation if using the corporate business structure.
Another key feature is the accounting method used by corporations. Generally, corporations must use the cash method of accounting, however, S Corps with no inventory need not use this method. This method indicates that income is taxable when it is receivedand expenses are deductible when they are paid.
S Corps have the same general corporate formalities as C Corporations – the business must file the articles of incorporation, hold periodic meetings, keep meeting minutes from all meetings, and allow shareholders to vote on the significant business decisions being made.
Time Period to Elect S Corp Status
If the business wants to elect S Corp status, then it must do so no later than 75 days after the first day of the taxable year. For example, if your business starts on January 15, then you must elect Subchapter S Status on or before March 23. There is no fee associated with electing S Corp status. However, electing this status requires the consent of all shareholders. Also, some states treat S Corporations differently. In fact, some states disregard S Corps altogether.
Revocation of S Corp Status
An S Corp can revoke its status by either failing to meet the requirements for eligibility or by filing a request with the IRS no later than 75 days after the first day of the taxable year indicating that it no longer wishes to be treated as an S Corp. Once the revocation becomes effective, your business will be treated as a typical C Corporation.
S Corp vs. LLC
When it comes to choosing which type of business structure is best for you, a lot of businesses have difficulty choosing between an S Corp and an LLC, as both business structures share similar characteristics, i.e., both business structures offer limited liability protection and operate as pass-through tax businesses. With that said, stock in the S Corp can be easily transferred, while ownership in an LLC cannot. This means that the interest in the S Corp can be given to any other current shareholder or new shareholder who is eligible to receive it. The shareholder wishing to transfer his or her interest need not obtain approval from the other shareholders.
While you can only issue one share of stock in an S Corp, you can still designate voting/non-voting shares, meaning that you can transfer non-voting stock to your dependents, allowing them to have greater ownership in the business, while you are still in total control of the significant decisions of the business. In contrast, LLCs need the approval of all other owners in the LLC before they can sell their interest.
S Corp Form 1120-S
While an S Corp doesn’t have to pay corporate income taxes, the company still needs to file an informational tax return known as Form 1120-S with the IRS. This form will identify the company’s profits, expenses, dividends paid out, and other items that are distributed to shareholders. The distributions that were made to the shareholders will also be identified on Schedule K-1, which is a form that the S Corp must fill out for every shareholder of the business.
In addition to these forms, you will also need a profit and loss statement, along with balance sheets for the beginning and end of the taxable year, as you will need to input this information onto Form 1120-S. You will also need to include information on the shareholder/employees compensation, the cost of goods sold, and any assets that depreciated throughout the taxable year.
If you need help learning more about an S Corp, or need assistance forming your S Corp, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only 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.