Here Is Everything You Need To Know About S-Corporations
Figures from the U.S. Small Business Administration show that 86.6 percent of nonemployers in 2017 preferred sole proprietorships. But more than half of small employer firms chose to form an S-corporation. Selecting an S-corporation ensures pass-through taxation, allowing business owners to pass business taxes onto their shareholders. The decision to become a “S-corp” might result in significant tax savings for companies that meet the requirements. When individuals make casual references to corporations, they are most usually referring to the kind of company that is the most prevalent and well-known: a “C-corp,” which is subject to a corporate income tax and may have an unlimited number of stockholders. But the label of “S-corp” refers to something else entirely. Our manual provides an overview of S-corps and compares c corporation vs s corporation.
Understanding the S-Corporation Structure
S-corporations are not business entities but a tax classification used by business entities like LLCs and corporations. These businesses can pass everything from income to losses to their shareholders and allow business owners to choose to pay taxes as employees. Therefore, owners don’t pay self-employment and income tax on their company distributions but only income and FICA taxes on their distributions. TRUiC’s guide on what is an S-corporation and when it is viable can help you see if it’s worth seeking this status.
When To Choose an S-Corp
Choosing an S-Corp requires that your small business meet specific IRS requirements. For example, the company has only up to 100 shareholders and issues just one type of stock. In addition, its owners are either U.S. citizens or hold permanent residence status, and the business owner is a private individual and not an entity. The limitation on entities includes other S-corps, C-corps, LLCs, partnerships, sole proprietorships, and non-profit organizations.
The company must also make enough profit to pay a salary within reason and have a minimum of $10,000 annual distributions. Additionally, the tax savings must outweigh the payroll and accounting costs.
Importance of Salary and Distributions
Working out a reasonable salary is essential because it must match what someone else earns for the same job. You can research salaries on the U.S. Bureau of Labor Statistics or Glassdoor websites to determine how much you must make. S-corps face increased scrutiny by the IRS, and they will check if your salary matches your duties.
Also, a small business needs at least $10,000 in distributions to create tax savings under an S-corp. S-corps need a professional accountant to maintain company books and payroll, so consider these accounting fees against the tax savings for your small business.
Who Can Form an S-Corporation
There are two types of business structures that can choose S-corp status: LLCs and corporations. You can do this by requesting the status from the IRS. You can also convert an existing LLC to an S-Corp.
Note: Corporations don’t usually benefit from an S-corp status because it negates the corporation benefits.
Business Operations and Management Structures
S-corps have a rigid structure with formal operational requirements. Some internal formalities required include the strict adoption of corporate bylaws, initial and annual shareholders’ meetings, keeping meeting minutes and retaining them, and meeting the regulations on issuing stock shares.
Unlike LLCs, whose members have an operating agreement that outlines management, S-corps shareholders choose a board of directors and corporate officers. The board of directors oversees the administration, making the major corporate decisions. The corporate officers, usually include a chief executive officer (CEO) and a chief financial officer (CFO), manage the company’s business operations.
Finally, both LLCs and S-corps are perpetual, but stock transferability is contingent on the operating agreement for LLS, whereas those of an S-corp are easy to transfer.
How To Elect S-Corp Status
Before choosing your S-corp status, you must first form an LLC in your state by following just a few easy steps, and you can do it yourself. However, business service providers also offer company formation services at excellent prices. One of the most popular is ZenBusiness.
If you decide to do your legal business formation yourself, the steps are straightforward. First name your LLC, choose a registered agent and file the articles of organization with the state. The next step is to create your business operating agreement. Finally, request your employee identification number (EIN) from the IRS online and, at the same time, file Form 2553 requesting the S-corp status.
C corporation vs S corporation
Formation — The default corporate structure is a C corporation. You are given the designation of C Corp when you submit your state’s articles of incorporation. You must submit Form 2553 if you wish to be a S Corporation. To continue to be a S Corp, there may be more paperwork to fill out.
Finance — C Corporations are subject to two forms of taxation: corporate income tax and federal income tax paid by shareholders as dividends. S Taxation is passed through to corporations. Shareholders do this by declaring corporate profits and losses on their personal tax returns. Their personal tax return is their sole source of taxation, thus. No business tax is imposed.
Ownership – There are no limitations on ownership for c corporation vs s corporation. There may be as many owners as you’d want, and anybody can be an owner. S Corps may only have 100 stockholders, all of whom must be Americans.
Small businesses growth continues unabated throughout the U.S. The most popular legal formation chosen is LLC for the personal liability it offers them, but many LLCs are also opting for S-corporation tax status. S-corps are increasingly popular among business owners in the U.S. because of the pass-through taxation benefits. Despite the restrictions, many small businesses can easily qualify, and it’s worth looking into it for yours.
Brantlee Bhide is a project manager at HB Consultancy. She has 16 years of experience working as a project professional across varying industries, countries, and cultures. She operates in both business and technical domains using an approach that she developed.