What is an S Corporation: Everything You Need to Know
What is an S-Corporation? It is a corporation that's elected S-Corp status (under Subchapter S) with the IRS for tax purposes.3 min read
2. Advantages of S-Corps
What is an S-Corporation? It is a corporation that's elected S-Corp status (under Subchapter S) with the IRS for tax purposes.
What Is an S-Corp?
Some business owners may consider an S-Corp to be a “lite” version of a C-corporation. If your corporation meets certain requirements, it may elect for S-Corp status. Requirements are the following:
- S-Corps have a max of 100 shareholders.
- They must be domestic business entities.
- Shareholders must be legal U.S. citizens or residents.
- S-Corps can only issue one class of stock.
S-Corps enjoy the limited liability of a corporation as well as the tax rate of individual shareholders, and they also provide such benefits as perpetual existence and investment opportunities.
S-Corp shareholders elect a board of directors that's responsible for managing the company. Directors appoint officers, who are responsible for a company's day-to-day operations.
Unlike C-Corps, an S-Corp may not have to file taxes quarterly, depending on if it has employees. S-Corps still file a federal return annually, but they're not subject to the double taxation of C-Corps.
All businesses that file to incorporate get the default classification of C-Corp. After incorporation, business owners may elect S-Corp status as long as they meet the requirements. The S-Corp designation was created to encourage the creation of small businesses.
Think about your long-term goals when deciding whether or not an S-Corp is ideal for your business. For instance, if you want shareholders from outside of the U.S. or you wish your company to be publicly traded, a C-Corp is probably a better option since this business structure can offer more than one class of stock and has no limitations on ownership.
If you have no plans to grow your business outside of the U.S. and you're fine with other S-Corp guidelines, you can avoid some hassles and save money by operating as an S-Corp.
Advantages of S-Corps
Following are some of the advantages that S-Corps offer.
Shareholders, directors, officers, and employees are not held personally liable for business debts or obligations. In general, creditors are unable to go after personal assets to recover business debts.
This is why it's important for owners not to treat the business as extensions of themselves, which may be referred to as "disregarding the corporation form." It can take the form of mixing business and personal funds or making business decisions without first passing resolutions. In that case, creditors may be able to hold owners personally liable for business debts and obligations; this is typically referred to as "piercing the corporate veil."
A corporation may also lose its "corporate veil" if the state terminates the business for failing to file necessary forms or paying taxes and fees.
An S-Corp's income flows through to company shareholders, and they report their share of profits and losses on their personal tax returns. Generally, an S-Corp owes no tax liability.
Because owners pay taxes on the business income based on the individual tax rate, taxes may be lower than C-Corp taxes, which are taxed at the corporate tax rate.
S-Corps can attract investors by selling shares of stock.
If an owner leaves the S-Corp or dies, the business can continue on.
Lower self-employment taxes
Owners in S-Corps who also work as employees don't have to take on the full burden of self-employment taxes because they're treated and taxed as regular employees. The business picks up a portion of withholding taxes, reducing an Individual's share.
You'll enjoy some flexibility in how ownership is managed in an S-Corp. S-Corp stock is freely transferable, unlike in an LLC. Therefore, S-Corp shareholders are free to sell their ownership interest without having to get the approval of other owners. Transferring ownership requires no compliance with complex accounting guidelines or adjustments to property basis.
Flexible characterization of income
S-Corp owners have a good amount of flexibility in how they characterize their income for tax purposes.
S-Corps have some distinct advantages over other business types. Depending on the type of corporation you operate, you may find electing S-Corp status beneficial. You might want to consult with legal and tax professionals before making the election to ensure you choose what's best for your business.
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.