Everything You Need to Know About an S Corporation
An S corporation is a type of business entity that a business owner can register for after meeting particular Internal Revenue Code requirements. Ultimately, an S corporation allows a business to enjoy the regular benefits of being a corporation while also enjoying the tax-exempt status of a partnership.
Would your business fit well to an S corporation classification? Keep on reading to find out.
What Is an S Corporation?
In the simplest sense, an S corporation is a type of tax entity. It is a corporation, but it is called an S corporation because of its tax-exempt status under section 1202 of the Internal Revenue Code. This tax-exempt status means that any income the company earns is not subject to a corporate income tax. Instead, the company income is passed on to the shareholders, who are responsible for paying income tax on it through their personal income tax returns.
An S corporation enjoys the benefits of a regular corporation, such as limited liability protection and the ability to raise capital. But it is not subject to business taxes on income.
Furthermore, an S corporation can only have one class of stock. This means all shareholders must have equal ownership rights and share in profits and losses equally.
How Can You Qualify for an S Corporation Status?
Owners of a business entity that wants to qualify for an S corporation status must meet a number of requirements.
First of all, there can only be one class of stock, meaning all shareholders share the same amount of rights in the company, including the right to vote and the right to receive dividends.
Secondly, shareholders must be required to pay active management fees. Shareholders who don't pay management fees cannot be considered part of the active management of the company.
Thirdly, there must be no more than 100 shareholders. The shareholders must also be U.S. citizens or resident aliens.
Finally, the entity must be operated as a U.S. domestic corporation or have a permanent place of business within the U.S.
How Is an S Corporation Different from a C Corporation?
The primary differences between a C corporation and an S corporation are the tax characteristics and the legal structure.
As mentioned above, the biggest difference between a C corporation and an S corporation is tax-exempt status. While a C corporation is subject to corporate income tax, an S corporation is not subject to any sort of tax.
C corporations are also incorporated under each state's corporation law, while an S corporation is incorporated under federal law. This makes S corporations subject to federal taxes, which exempts them from state taxes.
What Are the Advantages of Registering as an S Corporation?
Tax exemption is the primary advantage of registering as an S corporation. The fact that S corporations are not subject to corporate income tax means that any income from the business is subject to the income taxes of the shareholders instead.
S corporations can also issue tax-free distributions of profits to shareholders. This allows the company to distribute profits to shareholders without any strings attached, avoiding the need to distribute profits as salaries, wages or other taxable income.
Because this is an "S corporation," the company can also enjoy limited liability protection. This means that the owners of the company cannot be held personally responsible for any lawsuits or debts the company incurs.
Final Thoughts
The primary benefit of registering a business as an S corporation is tax exemption. However, whether or not it makes sense for your small business to register as an S corporation depends on your business, your tax situation, and your goals for the company.
If you are on the hunt for business tax filing services, work with us at Tottax. Our experts can help you identify the entity type and business structure for your company, including the tax preparation process for your business. Give us a call at (303) 536-1757 to learn more.
