There are various methods of forming a business in the United States, and an S corporation is one of them. S-corporations are pass-through entities, which means that the corporation is not federally taxed. Instead, each shareholder is taxed on their own income through their personal income tax return.
The Difference Between an S-Corp and a C-Corp
Although both S-corps and C-corps are both corporations, they are taxed differently. S corporations receive more tax benefits because they are considered a flow-through tax entity.
Similar to a sole proprietorship, partnership, or LLC, the shareholders (owners) of an s-corporation must have their profits and losses flow through their personal tax returns.
All S-Corps Start as C-Corps
In order to become an S corp, a corporation must first become a C corp. After this is complete the transition to an S-corp is facilitated by filing a subchapter S-corp status, along with meeting the following requirements:
- No more than 100 shareholders
- Shareholders are individuals, not corporations
- One class of stock
- All shareholders must be U.S. citizens or residents
How is an S Corp Taxed in Delaware?
S-Corps are pass-through entities which means that they are not required to file and pay taxes as a corporation. Instead, this responsibility is passed down to the owners, who pay taxes individually.
Because S-corporations are employers automatically, every owner of an s-corp is considered an employee. This means that monthly payroll deposits must be filed, and all employer regulations must be followed.
Because of your role as an owner, as part of an S-Corporation, you will be required to pay self-employment taxes only on the salary you receive from the corporation.
Annual Income Tax
Unlike a C-corp, as an S-corp you will not be required to make quarterly estimated tax payments. Instead, annual tax payments will be made through the owner’s profits.
Some states require a minimum annual franchise tax when it comes to S-corporations. Delaware’s annual franchise tax is based on how many shares exist:
- 5,000 shares or less: $175
- 5,001-10,000 shares: $250
- Each additional 10,000 shares or portion: Additional $75
- The maximum annual tax is $180,000
Failure to pay the franchise tax will result in a $200 penalty, as well as interest charges at 1.5% per month. It will also prevent the corporation from obtaining a certificate of good standing. If you continue to fail to pay franchise taxes it can lead to your corporation being declared void by the State.
Why Choose an S Corporation?
One might wonder the purpose of applying for s corporation status versus the standard C corp status. The main benefit is the ability to provide preferred shares. This means that you can avoid double taxation and avoid liability at the same time. If you are looking to protect your personal assets from business creditor claims, an s corporation is the best solution.
Is an S Corporation for Everyone?
If you are a sole proprietor, then forming as an S-Corporation is most likely not worth it. There are a number of requirements and loops to jump through as an s-corp. This includes:
- Holding a board of directors
- Recurrent shareholder meetings
- Filing annual reports
- High levels of regulatory compliance
- File payroll taxes despite being the only “employee”
Not only is it a hassle to jump through these hoops, but they can end up creating unnecessary expenses.
Why would an LLC elect to be taxed as an S Corporation?
When forming an LLC in the state of Delaware you can choose the method in which you prefer to be taxed. There are several forms of taxation available, and while the LLC is the most flexible in being able to choose any tax election, some LLCs choose to be taxed as an S-corp. This is because an S-Corp election can provide some of the best tax savings along with liability protection.
Advantages and Disadvantages of an S-Corp
- Pass-through taxation: While owners are required to report their portion of profit and loss, they will only be required to pay taxes on their own portion within their own tax bracket.
- Limited liability: Similar to an LLC, all the company directors, officers, shareholders, and employees will avoid personal asset-liability when it comes to business debts.
- Unlimited lifetime: When an owner of the company passes away it will not affect the functionality of the company. The same is to be said if an owner leaves the company, the business will always continue to operate.
- No double taxation: Rather than income be taxed twice as it is done in a C-Corporation, an S-corporation’s income will only be taxed one time, through the owner’s personal tax returns.
- More investment opportunities: Sell shares of the stock publicly or privately.
- Annual tax filing: Only file taxes once annually versus quarterly as a C-Corp, which must file quarterly.
- Owners must be citizens or residents of the United States.
- There may not be more than 100 shareholders which produce limited ownership and ability to expand.
- Multitude of ongoing expenses and formation costs. You must file Articles of Incorporation, as well as hold a registered agent, and pay various fees.
- Mistakes regarding taxes may disqualify you from S-Corp status, requiring double taxation and a tax obligation.
Is an S-Corp Right for You?
One of the main advantages of forming as an S-corporation is that there is always a high level of personal liability protection for its owners. With similar tax benefits of flow-through tax entities, an s-corp provides overall flexibility. For information about forming a Delaware S-corporation contact us today.