What Is an S Corporation (S Corp)?
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It's kind of like the lite version of a c corporation (c corp). An s corp offers investment opportunities, perpetual existence, and that coveted protection of limited liability. But, unlike a c corp, s corps only have to file taxes yearly and they are not subject to double taxation. Read on if this sounds enticing for your business.
S Corp Advantages
Read 'em and weep.
- Limited liability. Company directors, officers, shareholders, and employees enjoy limited liability protection.
- Pass-through taxation. Owners report their share of profit and loss on their individual tax returns.
- Elimination of double taxation of income. Income is not taxed twice – once as corporate income and again as dividend income.
- Investment opportunities. The company can attract investors through the sale of shares of stock.
- Perpetual existence. The business continues to exist even if the owner leaves or dies.
- Once-a-year tax filing requirement. Versus c corps, which must file quarterly.
S Corp Disadvantages
There's a lot to love, but here's a few things to consider before adding the 's' to your corp.
- U.S. citizens and permanent residents only. Unlike the c corp and LLC (Limited Liability Company), you have to be a legal resident of the U.S.
- Limited ownership. An s corp may not have more than 100 shareholders.
- Formation and ongoing expenses. It is necessary to first incorporate the business by filing Articles of Incorporation with your desired state of incorporation, obtain a registered agent for your company, and pay the appropriate fees. Many states also impose ongoing fees, such as annual report and/or franchise tax fees.
- Tax qualification obligations. Mistakes regarding the various filing requirements can accidentally result in the termination of s corp status.
- Closer IRS scrutiny. Payments to employees and shareholders could be distributed as either salaries or dividends. Each are taxed differently, which is what leads the IRS to scrutinize that distribution more closely.
S Corporation vs. C Corporation
What is an s corp?
As we described above, an s corp is something like the lite version of a c corp. That is, when you consider its growth potential and organizational structure.
Every business that files for corporation is first classified as a c corp. Once that's complete, you have to then file for subchapter s corp status and meet all requirements for an s corp – namely, have fewer than 100 shareholders who are all individuals, not corporations; have only one class of stock; and be owned by U.S. citizens or resident aliens. All of which are pretty easy requirements for most small businesses.
Back to the perk of saving money. An s corp is not subject to double taxation as a c corp is. That means that an s corp's revenue is not taxed at the corporate level. It's only taxed when paid out as salaries or dividends to shareholders. That alone could save an s corp hundreds of thousands of dollars. For this reason, a c corp makes very little sense for a small business. But if you opt for an s corp, make sure you have a solid accountant as one mistake in filing can send your company back to c corp status, leaving it open to be taxed twice.
Find out which corporation is right for your business with our Business Wizard!
How to Start and Form an S Corp
- Choose a legal name and reserve it, if the Secretary of State in your state does that sort of thing (not all do).
- Draft and file your Articles of Incorporation with your Secretary of State.
- Issue stock certificates to the initial shareholders.
- Apply for a business license and other certificates specific to your industry.
- File Form SS-4 or apply online at the Internal Revenue Service website to obtain an Employer Identification Number (EIN).
- Apply for any other ID numbers required by state and local government agencies. Requirements vary from one jurisdiction to another, but generally your business most likely will be required to pay unemployment, disability, and other payroll taxes – you will need tax ID numbers for those accounts in addition to your EIN.
- File the IRS form 2553 within 75 days of your corporation formation.
Corporations that meet certain requirements can elect an s corporation (s corp) status with the IRS. This federal tax status enables companies to "pass through" their taxable income or losses to owners/investors in the business, according to their ownership stake in the business.
By default, companies that do not specify a tax status with the IRS are considered to be c corporations (c corps) – which means that they will be taxed as a c corp. On the other hand,by electing s corp status, a corporation can eliminate the disadvantage of "double taxation" of corporate income and shareholder dividends associated with the c corp tax status.
The cost and tax structure of a s corp can vary. Say a corporation makes $300,000 in a given year – if it is an s corp, the business itself will not be taxed for that amount; instead, the company's shareholders will be required to pay taxes according to their share of the company. In this scenario, if the company has three shareholders, each with an equal share of company stock, each shareholder will pay taxes on $100,000.
If the c corp makes $300,000 in a year, then the company would pay taxes at the current federal corporate tax rate of about 34%. If the remaining profits of $198,000 are distributed to the three shareholders as dividends, each shareholder will pay taxes on $66,000 in dividend income at the current federal dividend tax rate of 15%.
S corps, like other types of corporate entities, also keep owners' personal assets safe from company debt and judgments against the business.
To learn more about double taxation, watch our video.
What is pass-through taxation?
One possible tax advantage of an s corp is pass-through taxation. Corporations can elect "pass-through" taxation by applying to the IRS for status as a Subchapter S Corporation. The s corp provides the same protection from personal liability as a c corp. However, owners of an s corp can report their share of profit and loss in the company on their individual tax returns. An s corp files IRS Form 1120s to report income.
Where should I incorporate my business?
Most companies form their corporations in the state in which they will primarily operate or in the state of Delaware in order to have access to its courts and business-friendly laws. Advantages of forming a corporation in your home state include:
- Fewer complications, if you only plan to operate the business in your home state.
- No need to pay franchise taxes or file annual reports in more than one state.
- Less cost.
Many companies conduct business throughout the United States and abroad. An s corp with business locations in multiple states may incorporate in a single state, then register to do business in other states. This means that s corp must formally register, file annual reports, and pay annual fees in every state in which they conduct business.
Remember, you must separately apply for s corp tax status through the IRS by filing Form 2553.
- Do I need an attorney to form a corporation?
- What are the requirements to form an s corporation (s corp)?
- What is the cost of setting up an s corp?
- Is an s corp required to have a registered agent?
- What do I need to do after I form my s corp?
- What is the organizational structure of an s corp?
- Can an s corp own an LLC?
- Can the personal asset protection provided by forming an s corp be taken away?
Do I need an attorney to form a corporation?
No. You can prepare and file necessary paperwork yourself, or you can use incorporate.com to incorporate your business. If you are unsure whether incorporating will benefit your business, please call us at 800-818-6082. Our Business Specialists are happy to provide you with the information you need to make the right decision.Back to Top
What are the requirements to form an s corp?
incorporate.com will guide you through the steps to incorporate your business either online or by telephone. We simplify the process of registering your new s corp
- Form your s corp online or contact a Business Specialist at 800-818-6082 (toll-free) or 302-636-5440.
- We assign your order to a Business Specialist, who contacts you if there are any problems with the preliminary name search.
- We complete Articles of Incorporation on your behalf. A few states require us to get your signature on the completed documents before submission. Normally, we submit documents directly to the state.
- We file your documents with the state.
- We forward the state approval notice to you (generally within 5-10 business days, but turnaround time varies by state).
- You apply for s corp status through the IRS by filing Form 2553 (this form is included with your formation package).
What is the cost of setting up an S Corp?
The costs associated with setting up an s corp, LLC, and c corp are similar. However, there are other intangible factors you must take into account. Every s corp is unique and comes with its own set of advantages and disadvantages. Among the subchapter s corp requirements you must weigh when considering this particular status is that s corps must file articles of incorporation, keep a record of corporate minutes, hold shareholder and director meetings, as well as allow their shareholders to weigh in with a vote concerning company decisions. S corps can also only offer common stock to investors, making fund-raising more difficult. If you are still undecided as to the pros and cons of declaring your business an s corp, please contact incorporate.com to speak to someone who may be able to set you on the right path.Back to Top
Is an s corp required to have a registered agent?
Yes. State laws require all corporations to maintain a registered address with the Secretary of State in each state where they do business. The person or company located at that address, known as the registered agent, must remain available during all business hours. A registered agent receives and forwards important legal documents and state correspondence on behalf of the business.Back to Top
What do I need to do after I form my s corp?
- Most states require s corps to file annual reports and pay franchise taxes to maintain their good standing. Failure to file annual reports and pay franchise taxes can result in fines, notices, and the inability to conduct business. You may be able to file many of these S Corp documents online. incorporate.com can help you ensure each of your forms are correctly filled out and submitted according to schedule.
- State laws require s corps to hold annual meetings of shareholders and directors and record meeting minutes. Owners and directors of an s corp use corporate minutes to reflect changes in management and important corporate activities.
- Additionally, almost all state, county, and local governments require s corps to complete business license, permit, and tax registration applications before beginning to operate.
What is the organizational structure of an s corp?
The company is owned by shareholders, who elect directors. The directors set a vision for the corporation and are responsible for the management of the corporation. The officers and managers hired by the directors are responsible for carrying out the vision on a day-to-day basis.Back to Top
Can an S Corp own an LLC?
An s corp can own an LLC. However, only single-member LLCs can own a stake in an s corp. One of the tax advantages of an s corp is similar to that of an LLC in that both can pass their profits and losses through to their personal income tax report each year.Back to Top
Can the personal asset protection provided by forming an s corp be taken away?
Generally the owners of a corporation cannot be held liable for the debts and obligations of the corporation. However, if owners treat the corporation as an extension of themselves – sometimes referred to as "disregarding the corporation form" – such as by commingling personal and corporate funds or making important decisions without holding board meetings or passing resolutions, then creditors can attempt to hold owners liable for the debts and obligations of the company-often called "piercing the corporate veil." The "corporate veil" can also be lost if a corporation is terminated by a state for failure to file required forms or pay required fees and taxes.Back to Top
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