There are different types of business entities formed in the United States, and one of the most popular forms is the corporation. Within the corporate structure there are both c corps and s corps. Although C corporations are the standard, S corporations are a more attractive option.
What is an S Corporation?
S corp are pass-through entities which makes them different from a standard c corporation, and similar to an LLC S corporations are not subject to federal income tax, and instead, all the profits and losses are passed on to the shareholders. S corps can be publicly held, but there are also specific regulations that must be met in order to qualify for s corp status.
What’s the Difference Between an S Corporation and a C Corporation?
The main difference between an S-corp versus a C corp is that an S corp is given more tax benefits. S corps are considered to be a flow-through tax entity, similar to an LLC, sole proprietorship, or partnership. In order the be taxed as an s corp, these are the requirements:
- Having 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
How is an S Corp Taxed?
Corporations that choose to elect taxation as an S-corp, become pass through entities. The s corp itself will not pay taxes, rather, the owner will pay taxes on the profits and losses of the company. This is done on the personal tax return of the owners (shareholders).
Another thing to note is that the profits of an s corp are taxed when paid out as salaries or dividends to shareholders. For a small business this might not mean much, but it can save a lot for large corporations.
It is important to be careful when you file as an s corp because even if you should qualify but you make a small mistake, it could completely jeopardize your s corp status. Then, you would be taxed as a C corp.
Other S Corp taxes include:
- Payroll taxes: In Texas, the minimum payroll tax rate is 0.31% and the maximum rate is 6.31%
- Annual franchise fee: The average franchise fee for Texas businesses is around 1%.
Why Choose an S Corporation?
One reason that a business might for as a corporation in general, is because it can be publicly traded, with shares available for purchase. This makes it easy to obtain funding. Choosing to be an S corp rather than a c corp, provides many advantages. By default, a corporation must pay its own taxes. This eventually leads to double taxation, but an s corp avoids this.
S corp owners only need to pay taxes on their personal income tax return, leading to more profits for the corporation overall. This sounds great, but it might not be right for a small business because it requires paying payroll which can be expensive.
Additionally, an LLC can elect any form of taxation it wishes. In some cases an LLC may elect the taxation of an s corp in order to maximize savings.
Advantages and Disadvantages of an S Corp
Here are a few advantages and disadvantages of an S corporation.
- Limited liability: Company directors, officers, shareholders, and employees are given personal liability protection through an s corp.
- Pass-through taxation: All owners report their share of profit and loss on their individual tax returns. This is then only taxed at the personal level, similar to an LLC.
- Elimination of double taxation: S corps are not taxed twice, while c corps are taxed at the corporate and individual level.
- Investment opportunities: Because stocks are easily sold and purchased, an s corp can easily obtain funding.
- Unlimited life: Should any shareholders die the corporation will continue to live on and function as normal.
- Once-a-year tax filing requirement: C corps file estimated taxes quarterly, but s corps file annually.
- Only U.S citizen and permanent residents may form the shareholders
- There may not be more than 100 shareholders involved.
- Formation and ongoing expenses
- Closer IRS scrutiny
If you want to create an S corporation in Texas, get help from a business lawyer. A business attorney will be able to tell you if an S corporation is right for you.