S-corporations offer several important tax benefits to companies that qualify for this status. Most corporations are C-corporations, which a pay corporate income tax with unlimited shareholders. S-corporations work differently. Here, we describe what they are, their benefits, and how to choose whether an S-corp is right for your business.
At Kondori & Moorad, LLP, a qualified business formation attorney can help you pick the right type of corporation for your company. We provide personalized advice and customized plans to maximize your business potential.
WHAT IS A CORPORATION?
Before defining an S-corporation, it is critical to know the definition of a corporation. This is a type of business entity formed by filing incorporation documents with the state. Corporations have shareholders, officers, and directors. Shareholders are the owners of the corporation while the officers and directors help manage the companies operations.
A corporation is distinct from its shareholders, and is its own legal entity. Shareholders are not personally responsible for the debts of the corporation. Corporations must also hold regular meetings and keep corporate records.
WHAT IS AN S-CORPORATION?
Most corporations are C-corporations. S-corporations are a special tax designation which is available to certain types of corporations. They get their name from subchapter S of the Internal Revenue Code. The defining characteristic and advantage of an S-corporation is its “pass through” taxation structure.
To qualify for S-corporation status, businesses must:
- Maintain domestic corporation status
- Have allowable shareholders such as individuals, estates, and trusts
- May have shareholders that are partnerships, corporations, or non-resident aliens
- Have 100 or fewer shareholders
- Maintain only one class of stock
- Not fall into an ineligible category (i.e. insurance companies, domestic international sales corporations, specific financial institutions)
HOW TO APPLY FOR S-CORPORATION STATUS
To apply for S-corporation status, the business must be incorporated first. It can then file Form 2553, Election by a Small Business Corporation. All shareholders must sign the form.
The form states that the IRS will accept the S-corporation status only if all of the qualifications are met. An attorney can help apply for S-corporation status to help you gain its benefits.
BENEFITS OF S-CORPORATION REGISTRATION
There are several advantages of filing for S-corporation registration if your company qualifies. These include:
- Pass Through Taxation: S-corp businesses do not pay taxes at the entity level like C-corporations. Instead, income passes directly through to the shareholders to prevent double taxation.
- Personal Income Tax Benefits: S-corp status helps lower personal income tax obligations for the business owners. S-corp owners can often reduce their self-employment tax and make several deductions available for individual owners.
- Easier Asset Transfers: An S-corporation is better able to transfer interests or change property bases with adverse tax effects.
- Corporate Dividends: S-corporation shareholders area allowed to earn salaries, be employees, and receive corporate dividends that may be tax free, if the distribution does not exceed the stock basis. Otherwise, any excess is taxed as capital gains.
POSSIBLE DISADVANTAGES OF S-CORPORATIONS STATUS
While there are many benefits, there are some potential disadvantages of S-corporation status:
- Strict Distribution Rules: S-corporations must allocate profits and losses strictly based on the ownership percentage or share numbers.
- Scrutiny by IRS: The IRS carefully scrutinizes how S-corporations pay employees to ensure no company skirts tax laws. Some companies try to disguise salaries as corporate distributions.
- Approval and Removal of Status: This specialized status is subject to the IRS’s approval. This may be a lengthy process depending on the application. A corporation can lose S-corporation status for noncompliance or if it no longer meets the requirements.
CHOOSE THE RIGHT OPTION FOR YOUR CORPORATION
Choosing whether S-corporation status is right for your company is an important decision. A qualified business attorney can help you analyze your business and make the right choice. They can also help you apply for S-corporation status and meet the requirements you need.
At Kondori & Moorad, LLP, our business formation lawyers are here to protect your business and your bottom line. Contact us today to get started.