What is not required of an S corporation? An S corp is not required to pay business income taxes, and it is one of the reasons why it is a popular choice among so many business owners. S corps are a subchapter of a smaller corporation, and it is a tax code created by Congress in 1958. The S corp was designed to support small businesses and eliminate double taxation. 

If you want your business to be classified as an S corp, it must meet the following conditions:

  • Your business must be a domestic corporation.
  • The company cannot have over 100 shareholders.
  • Other entities cannot own an S corp, such as estates and trusts
  • The business cannot be owned by non-resident aliens.
  • Your business is only allowed one stock type (no tiered stock allowed)

Moreover, the business is governed via bylaws.

S Corp Benefits

An S corp provides the following tax advantages:

  • Tax Advantage: S corps do not have to pay federal income taxes, with the exception of passive income and capital.
  • Asset Protections: S corps safeguard your personal assets form judgments and creditor petitions. For instance, shareholders are not responsible for liabilities and debts incurred by the corporation. For the most part, the creditors cannot size personal assets to satisfy business debts. Liability is only limited to funds used to start the business.

S corps are a great option for businesses in the following areas:

  • Businesses that do not have large start-up capital.
  • Businesses that do not require major equipment purchases to begin operations.
  • Businesses that do not require effort or heavy expenses.
  • Businesses that are in the service fields (ex. Consulting)

In regards to dividend and wage structure, S corps offer a great deal of flexibility, but with it comes certain challenges. For one thing, the IRS searches for mischaracterizing of dividends and wages, which is why you should be careful when noting your income.

S Corp Basics

When creating your name, you can reserve it at the secretary of state office. From there, draft your articles of incorporation and submit to state authorities. The articles incorporation should include the following:

  • Company Name
  • Board of Directors
  • Share Numbers
  • Other Noteworthy Items

Further, you need to conduct regular meetings and record for a certain amount of minutes to maintain your business. You would also issue stock to the shareholders.

After, you would apply for the necessary businesses licenses or other certifications based on your industry. Next, you need to get an employer identification number (EIN), and you can get one for free via the IRS website.

Potential Consequences

It’s worth noting that consequences could follow if shareholders treat the business as a mere extension of themselves, otherwise known as “disregarding the corporation form.” This is achieved when shareholders mix corporate and personal funds.

Therefore, creditors could petition for personal assets due to the co-mingling of funds, and such a strategy is known as “piercing the corporate veil.” The corporate veil may also be penetrated if the business gets terminated by authorities for failing to pay taxes or adhere to filing mandates.

Also, you should be aware of tax mistakes. Though rare, you lose your S corp status if you’re not careful. You could make mistakes in areas that include:

  • Stocks
  • Election
  • Notification
  • Consent

S Corps Classification

When it comes to income characterization, shareholders can utilize a tax method that can save them on self-employment taxes. Shareholders taking on additional duties can also classify themselves as employees and take a salary.

An employee classification helps them save on self-employment taxes. Further, shareholders working as a salaried employee may also receive dividends or tax-free distributions. With that, the salary must be within reason and not artificially low. The IRS scrutinizes S corp classifications more seriously due to the potential for abuse.

Ownership Transfers

In regards ownerships transfer, you can do so easily without facing tax ramifications or entity termination. S corp ownership transfers also do not mandate property basis adjustments or adherence to complex accounting measures.

In regards to entity existence, the business will continue, even if the owners leave or die.

What is not required of an S corporation? To learn more,  submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s attorneys have law degrees from some of the best schools in the country and will use their law savvy and expertise to help you know more about the S corp process. Further, they will provide guidance on classifying your income properly so you can keep your business in good standing with authorities.