Subchapter S Corporation Advantages: Everything to Know
Subchapter S Corp advantages include personal liability protection, double taxation avoidance, lower income tax liability, and savings on self-employment taxes.3 min read
Subchapter S corporation advantages include personal liability protection, double taxation avoidance, lower income tax liability at personal tax rates, and savings on self-employment taxes.
What Is an S Corporation?
S corporations are among the three most popular types of business structures, the other two being LLCs and C corporations. An S corporation is treated as a pass-through entity for the purpose of federal taxes. Making an S corporation election can make a big difference on the way you handle business profits, distribute shares, and pay your taxes.
For filing an S corporation election with the Internal Revenue Service (IRS), you need to form a regular corporation first. Thus, in order to create an S corporation, you need to file the Articles of Incorporation with the relevant state authority.
An S corporation issues stock and functions through directors and officers just like a regular C corporation. The S corporation shareholders also have the benefit of personal liability protection, which means that their personal assets cannot be used to settle the liabilities of the corporation. At the same time, an S corporation enjoys the flexibility of passing through its income and losses to its shareholders just like in a partnership firm or a sole proprietorship concern.
An S corporation is not subject to income tax at the corporate level. The shareholders pay the taxes individually on the business profits they are entitled to. Thus, an S corporation saves you from "double taxation" that happens in case of C corporations.
Electing for the S corporation status can be beneficial in the following cases:
- If you are engaged in a service business
- If the startup cost is low
- If you need not invest in costly equipment to begin your business
- If there is a significant earning potential without much efforts and expenses
It should be noted that an S corporation is not actually a business structure by itself. You need to start off either as an LLC or a regular corporation in your state. Then, if you meet the eligibility criteria set by the IRS, you can choose to file the S corporation election for special tax treatment.
Who Can Qualify for S Corporation Election?
In order to qualify for the S corporation election, your business must meet the following conditions:
- All the shareholders of your corporation must be citizens or permanent residents of the U.S. As an implication of this, your corporation cannot have an LLC or a partnership firm as its shareholder.
- The number of shareholders must not exceed 100.
If you meet the above conditions and would like to apply for the S corporation status with the IRS, you should do so before the stipulated deadline:
- In case of a new business, you must file the S corporation election Form 2553 within 75 days of incorporation.
- In case of an existing business, you must file the S corporation election within 75 days from the beginning of your tax year.
S Corporation Advantages
An S corporation protects the personal assets of the owners from claims and liabilities resulting from the corporation's business.
An S corporation is treated as a pass-through entity for the purpose of federal income tax. This helps to avoid the usual double taxation of corporate profits, once at the corporate level and then again in the hands of shareholders when the profits are distributed as dividends. Shareholders can offset business losses against their personal income.
Lower Self-Employment Tax
- Only the owner-employees of an S corporation are liable to pay self-employment tax on the amount of salary they receive from the corporation.
- Shareholders need not pay self-employment tax on the distributed business income they receive.
- At the corporate level, the salary paid to owner-employees qualifies for deduction as business expense.
Easy Ownership Transfer
Compared to an LLC or a partnership firm, where more than 50 percent ownership transfer can terminate the entity, the ownership transfer of an S corporation is quite simple and straightforward. It does not require making adjustments to property basis or involve complying with complicated accounting rules.
Unlike regular corporations that, with some exceptions, must keep their accounts on accrual basis, S corporations are allowed to follow cash method of accounting, provided they don't have inventory.
The S corporation status gives more credibility to your business in the eyes of creditors, employees, customers, and suppliers, since they can see a certain level of commitment from the owners in managing the business.
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