Sub S Corporation: Everything You Need to Know
A Sub S corporation (S corporation) is a business that elects "small business" status allowing the corporation the benefit of limited liability, but the tax rate of the individual shareholder.3 min read
A Sub S corporation (S corporation) is a business that elects "small business" status allowing the corporation the benefit of limited liability, but the tax rate of the individual shareholder.
Overview of an S Corporation
To put it simply, a sub S corporation is a small C corporation that has met certain requirements and elects to be taxed as a pass-through business entity as per the Internal Revenue Code under Subchapter S.
Under Subchapter S, the corporation that has 100 shareholders or less can benefit from being taxed as a partnership. Additional requirements include the entity must be a domestic corporation, shareholders must be eligible to be part of the corporation, and there can only be one class of stock. Specific trusts and estates may also be shareholders.
Ownership interests in the corporations">S corporation are transferable. This can be done without the corporation facing negative tax consequences, complying with accounting rules, or making an adjustment to property. It also means shareholders can sell their interests without the need for approval of other shareholders.
Those who do not qualify to be shareholders are non-resident aliens, corporations, and partnerships. Specific domestic international sales companies, financial institutions, and insurance companies may not file as S corporations.
To choose the subchapter S election, the corporation must do so no later than two months and 15 days after the first day of the entities taxable year.
Advantages of an S Corporation
- In a corporate structure, taxes are paid on the profits. The owners are then taxed on the dividends received, which results in the double taxation of the corporation.
- With an S corporation, income is passed directly to its shareholders, which avoids the double taxation that involves the dividends distributed by public companies. The S corporation avoids the double tax while still maintaining the advantages of a corporate structure.
- If the S corporation suffers a loss, the owner's share of the loss is passed through to be filed with the individual's tax return.
- For small business owners, an S corporation is often more preferable than having a standard C corporation.
- S corporations provide the liability protection that comes with a corporation along with pass-through taxation afforded to partnerships and limited liability companies (LLCs).
- A limited liability company's existence can expire; an S corporation does not.
- It only takes one person to form a Subchapter S corporation.
- Employee wages are subject to self-employment tax while other bonuses and benefits are not taxed.
- As a separate entity, an S corporation retains the separate entity protection of a corporation along with the protection for owners against liabilities such as lawsuits or for being responsible for the corporation's debts, in many cases.
- Liability protection is not guaranteed as it can be invalid if an owner commits acts that include them in the responsibility for actions of the corporation, or if the owner takes responsibility for guaranteeing a loan(s).
- Shareholders may be employees, draw a salary, receive dividends from the corporation, or receive other tax-free distributions related to their investment in the business.
- If an owner classifies distributions as dividends or salary, it may help reduce their liability for self-employment tax and at the same time generating deductions for business expenses and wages paid.
Disadvantages of an S Corporation
There are two sides to everything and an S corporation is no exception as it has disadvantages as well as advantages. An S corporation must create and file the same paperwork applicable to a C corporation. This includes creating articles of incorporation, scheduling board of director meetings, keeping corporate minutes, and providing a means for shareholder voting.
There is quite a bit of additional paperwork involved with an S corporation that must be filed on a regular basis. A few of the forms include, but are not limited to, Form 4625 Depreciation, Schedule SE: Self-Employment tax, Forms 2553, 941, and 940, Schedule K-1, and an S corporation income tax return.
Along with filing its articles of incorporation with the Secretary of State, an owner must also obtain the services of a registered agent for the business, and pay any applicable fees. These may include annual report fees, franchise tax, or other ongoing fees.
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