US S Corporation: Everything You Need to Know
A US S corporation comes with a variety of benefits, especially tax advantages. Congress created the S corp in 1958 to provide additional advantages to small/family businesses, helping such businesses avoid double taxation.4 min read
A US S corporation comes with a variety of benefits, especially tax advantages. Congress created the S corp in 1958 to provide additional advantages to small/family businesses, helping such businesses avoid double taxation. You will have to consider alternative tax avenues as your business continues to grow, and an S corp provides various tax-saving strategies.
Expanding companies face a variety of complexities when tax season arrives, which is why an S corp is a popular business choice among small business owners. With that, an S corp tends to be misunderstood.
An S corp comes with certain drawbacks and benefits, but is a crucial instrument that protects owners from personal liability while providing them with pass-through taxation.
Corporations under an S corp classification may pass business income, deductions, credits, and losses to the shareholders. Unlike a C corp, S corps are also not subject to double taxation. In essence, an S corp is a variation of a C corp. The most notable aspect is that S corps allow profits and losses to flow from the business to the individual tax returns of shareholders. Moreover, S corps must be obtained via the IRS. An S corp provides investment opportunities, in addition to a perpetual existence.
S Corp Advantages
S corps provide the following core advantages:
• **Tax Advantages: S corps do not have to pay federal income taxes, with the exception of passive income and capital gains.
• **Asset Protections: S corps prevent creditors from going after your personal assets in the form of houses or cars.
• **Income Characterization: An S corp allows shareholders to classify themselves as employees and take a salary if they take an active role in the business. This also allows shareholders to pay less self-employment taxes. In addition, shareholders who take a salary can also receive dividends simultaneously. However, you must characterize your salary in a reasonable manner to avoid a response from the IRS.
When it comes to self-employment taxes, S corps provide a vital advantage over an LLC. Salary/bonuses are subject to self-employment taxes, but this does not include profits allocated to shareholders. You can reduce your tax balance by lowering business profits open to self-employment taxation.
C and S Corp Comparison
A C corp is a standard corporation, while an S corp is a special tax designation from the IRS. To get an S status qualification, you must submit Form 2553. Overall, C and S corps share the following similarities:
• **Liability Protections: Both entities offer liability protections, so shareholders (owners) are not personally responsible for liabilities and debts of the business.
• **Distinct Entities: S and C corps are different entities created through the state filing process.
• **Document Filing: Documents must be created through state authorities. You must also submit articles of incorporation, and it is the same document you would use for C and S corps.
• **Management Structure: Both structures are comprised of officers, directors, and shareholders. Shareholders are owners who appoint a board of directors. The directors oversee important aspects of the business and appoint officers to reside over daily operations of the business.
• **Business Formalities: Both entities must adhere to certain internal and external corporate formalities, such as filing annual reports, issuing stock, drafting bylaws, paying yearly fees, and holding meetings between shareholders/directors.
C Corp Advantages
When starting a C corp, you must know that it does come with certain advantages. For instance, C corps do not have caps on the number of shareholders, while S corps cannot have over 100 shareholders. In addition, S corp shareholders must be U.S. citizens/residents, while C corps foreign shareholders can participate in a C corp. Further, other entities such as LLCs and other corporations can own a C corp, but S corps have heavy restrictions on entity ownership.
When it comes to an S corp, you must meet certain standards:
• The S corp must be a domestic company
• Partnerships, corporations, and non-resident aliens cannot own stock in an S corp
• Certain industries, such as insurance companies, domestic international sales companies, and financial institutions cannot gain an S classification
Moreover, C corps can have tiered stock, but S corps can only have one stock class (no preferential stock allowed). Overall, C corps also provide greater flexibility as you expand your business, especially if you wish to your sell your corporation in the future. With that, an S corp is freely transferable, but LLC ownership transfers come with limitations. For instance, LLC transfers must gain the approval of shareholders before the transaction takes place.
To learn more about a US S corporation, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s lawyers will give you the ins and outs of an S corp, and will help you determine if such a tax classification is the best choice for your business. Moreover, they will guide you through the corporate registration process in addition to helping you through the necessary maintenance procedures to keep your business in good standing.