Setting up a corporation in the exact structure and format you want is not an easy feat. From LLCs, LTDs, C Corps to S Corps there are many different structures to choose from. Each of these options presents different benefits to the corporation, ranging from different varying taxing to protection for the owners or shareholders. In this article, we are going to gain a basic understanding of what an S Corps are and how they operate.
Let’s start from the beginning, an S Corporation or S Corp refers to a type of corporation that meets specific requirements by The Internal Revenue Code. In fact, S Corporation stands for Subchapter S Corporation, or sometimes Small Business Corporation. As the name suggests this structure of incorporating smaller businesses than say a C Corp, or an LLC. One of the main requirements of being an S Corp is to have 100 shareholders or less. Businesses structured as S Corps receive the benefits of being incorporated while being taxed as a partnership
S Corporation businesses are granted a special tax status by the IRS that lets them pass their income, deductions, and credits straight through to their shareholders. Technically speaking, most S Corporations do not pay income taxes. Instead of paying these taxes that all other corporations pay, the company’s structured as S Corps split their income or losses between their shareholders who are then report the said amount on their own personal income tax returns. Through this format of dispersing taxes to owners, S Corp businesses avoid double taxation.
As stated above there are a few different requirements to becoming an S Corp. A business attempting to be incorporated as an S Corp must be domestic business, with only 100 eligible shareholders. An eligible shareholder means any shareholder that is an individual, specific trusts, specific estates, and some tax-exempt organizations. Any partnership, corporation, and nonresident aliens, financial institutions, and domestic international companies, and insurance companies are exempt. Another one of the major requirements is about the stocks of the company. The corporation can only become an S Corp if they have only one class of stock.
Benefits of Being an S Corp
When a company registers as an S Corp, they automatically establish credibility with their potential customers, suppliers, investors and employees. Being an S Corp establishes a commitment to the company from the owner of the business. One huge advantage of being an S Corp is, in fact, the ability to skip out on paying federal taxes at the entity level. It is important to remember that an S Corporation is not a business entity but rather a tax designation. Thusly, an S Corporation cannot be incorporated.
A major benefit of being an S Corp is actually the level of asset protection it provides. The owners of an S Corp are provided with a limited liability protection. A limited liability protection signifies that the owners or shareholders personal assets are shielded from the claims of business creditors. S Corp structure also allows the owners of the business to accept their payments as salary and dividend payments. This helps reduce the taxes the shareholders since dividends are not subject to self-employment taxes. Also, S corporations can deduct salaries paid before computing the amount of income that is passed through to the shareholders.
Unlike LLCs, S Corporations can easily convert over to a C Corporation. An S Corporation simply has to file their choice to convert with the IRS. This changes their taxing system and allows them to be open to all forms of investors. This helps businesses who might start small to grow with time and stick to their long term plans.