Due to higher corporate taxes, double taxation, and more, the number of businesses electing an s-corporation structure has risen significantly.
As an s-corp, business owners not only avoid taxes on distributions and save on self-employment taxes, but they also receive limited liability protection.
However, with recent changes under the Tax Cuts and Jobs Act, an s-corp business structure may not be best for you.
In this article, we’ll discuss the details of an s-corp, why you should choose an s-corp, and how one works.
What is a S Corporation?
Within the corporate business structure are both c corps and s corps. Although C corporations are standard, S corporations are often a more attractive option. S-corps were formed by Congress to offer small businesses the best of a c-corp structure and partnership.
S-corps are pass-through entities, which make them like an LLC structure. Unlike c-corps, s-corps are not subject to federal income because all the profits and losses of the business are passed to the shareholders. Electing an s-corp business structure also lowers self-employment taxes by issues dividends.
What is the difference between an S corp and a C corporation
From taxes and formation to shareholders and fees, there are a few notable differences between an s-corp and c-corp.
S-corps are given more tax advantages because they’re considered a pass-through tax entity. However, for s-corps to elect this taxation, they must meet these requirements:
- Have fewer than 100 shareholders
- All shareholders must be individuals, not corporations
- May only have only one class of stock
- Must be owned by U.S. citizens or resident
When it comes to formation, a c-corp can be formed when you’re choosing the right business structure for your unique situation. However, an s-corp can only form if it’s already a c-corp.
How is an S Corp Taxed?
As previously mentioned, when a corporation elects s-corp taxation, it becomes a pass-through entity. This means the owner pays taxes on the profits and losses of the business on their personal tax return– the s-corp itself does not pay taxes.
The profits of an s-corp are only taxed when paid as dividends or salaries to shareholders. Depending on the type and size of your business, this can save your business a lot of money.
Filing as an s-corp should not be taken lightly. Even if you qualify, there are several minor mistakes you could make that would jeopardize your s-corp business structure. One small mistake can result in being taxed as a c-corp, which could be financially devastating if you are not prepared.
Other s-corp taxes to take into consideration are payroll taxes and annual franchise fees. Payroll taxes vary based on the state, as do the annual franchise fees.
Why Choose an S Corporation?
Many businesses choose an s-corp structure because it’s publicly traded with shares available for purchase. This ability makes obtaining funding easier and provides more advantages that a c-corp cannot partake in.
In addition to avoiding double taxation that c-corps are subject to, an s-corp tax structure also allows more profits for the corporation. And depending on the type and size of your business, this may be beneficial. For example, a smaller business may not like this structure because of payroll requirements, which are costly.
Advantages of an S Corp
Limited liability: Company directors, officers, shareholders, and employees are given personal liability protection through an s-corp.
Pass-through tax status: The s-corp does not pay taxes – the owners pay on their share of profits and losses on their personal tax returns.
Elimination of double taxation: S-corps are not taxed twice, while c-corps are taxed at the corporate and individual level.
Once-a-year tax filing requirement: C-corps file estimated taxes quarterly, but s-corps file annually.
Investment opportunities: Because stocks are easily sold and purchased, an s-corp can easily obtain funding.
Perpetual Existence: Should any shareholders pass away; the corporation will continue to live on and function as normal.
Disadvantages of an S Corp
- There may not be more than 100 shareholders involved.
- Only U.S citizens and permanent residents may form the shareholders.
- Formation and ongoing expenses.
- IRS scrutiny.
If you want to form an s-corp business structure, it’s best to consult wit ha business lawyer who is familiar with state laws. There are several minor details that should be worked out before electing an s-corp status. A business lawyer can advise on whether this structure is best for your unique situation.