What Does S in S Corp Stand For: Everything You Need to Know
What does S in S Corp stand for? It stands for Subchapter S in the Internal Revenue Code. Some corporations that meet certain requirements may elect S-Corp status for tax purposes or other advantages.3 min read
What does S in S Corp stand for? It stands for Subchapter S in the Internal Revenue Code. Some corporations that meet certain requirements may elect S-Corp status for tax purposes or other advantages.
S Corporation Overview
To qualify as an S-Corp, a business must meet certain requirements. S-Corps are corporations that elect to pass the following to their owners, or shareholders, for tax purposes:
- Corporate income
S corporations pay no income tax themselves, and this tax election is only for small businesses.
S-Corp shareholders report business income and losses on their individual returns. At the end of the year, the S-Corp files an information return, which lists all income, expenses, depreciation, etc. The business sends all shareholders a notice of their share based on their percentage of ownership.
By passing income directly onto shareholders, S-Corps avoid double taxation that public companies are subject to, while still enjoying some of the benefits that its corporate structure provides.
Partnerships, non-resident aliens, and corporations do not qualify to be S-Corp shareholders.
Who Can Be an S-Corp?
In general, you can elect S-Corp status only after obtaining a federal tax ID and incorporating your business. After that, you're responsible for ensuring that you meet the requirements for S-Corp election before filing.
S-Corp requirements are as follows:
- It's either a domestic corporation or a domestic entity that's eligible to be treated as a corporation.
- It files form 2553 with the IRS in a timely manner.
- It can have no more than 100 shareholders. For this requirement, a spouse can be treated as one shareholder. Check the requirements for additional situations in which you can treat certain entities as family members. All others count as separate shareholders.
- Shareholders must be individuals or certain estates, trusts, or exempt organizations.
- It cannot have any non-resident aliens as shareholders.
- It can only issue one class of stock.
- It must have or be willing to adopt a certain tax year, i.e., a natural business year or year elected under section 444.
- It has the consent of all shareholders to elect S-Corp status.
Advantages of S Corporations
Operating an S corporation can help increase a company's credibility with potential customers, investors, and suppliers.
Shareholders may also be company employees and receive salaries. In addition, they may receive dividends or other distributions. By classifying distributions as salary, an owner may pay less in self-employment taxes.
In essence, S-Corps are treated the same as partnerships for tax purposes. S-Corps don't pay business income taxes, so losses may offset other income on a shareholder's tax return.
For newly established businesses, the S-Corp election is beneficial from a financial standpoint because this tax status can help the company save money on taxes. For that reason, many companies elect S-Corp status early on and then make the switch to a C corporation later.
You can transfer interests in an S-Corp without facing negative tax consequences or complying with complicated accounting rules.
Disadvantages of an S-Corp
Once a corporation terminates its S-Corp status, it has to wait for a set period of time before it can make the election again.
If the IRS determines that an S-Corp's shareholder/employee wages are dividends, the company loses a deduction for compensation paid. When dividends are characterized as wages, the company pays higher employment taxes.
An S-Corp can also be terminated if mistakes are made in the following:
- Stock ownership
- Filing requirements
It does take time and money to elect S-Corp status. The S-Corp owner must file Articles of Incorporation with the state, pay all necessary fees, and select a registered agent for the company. Many states require owners to pay franchise tax and/or fees for annual reports.
Stockholders who are in high-income tax brackets will have their share of profits taxed at those rates. In addition, certain fringe benefits may not be tax-deductible, such as life and health insurance.
Small corporations may find S-Corp election beneficial, so it's worth considering if you meet all the guidelines. It's best for businesses that wish to remain on the smaller side, so if you have plans to expand internationally, a standard C-Corp would suit you better.
If you need help with forming an S-Corporation or other business entity, 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.