There are various business structures, so when forming yours, you will probably have multiple options. Chances are you will hear of S corporation and wonder the implication and how it stands out from other forms of a corporation. S corporation stands out from an LLC or partnership even though it is not a unique business form. It is a form of tax election that any LLC or small business can take.
The S stands for Subchapter from the US tax code. As a result, everyone who wants to make their small business formal should understand the implications and benefits of the corporation, S Corp, and LLC with an experienced attorney.
What is An S Corp?
S corporation is defined as a business entity that has decided to go for a special IRS tax election to dodge the double taxation common with corporations. With this form of tax election, each loss or profit from the corporation is passed to the shareholders and recorded on the personal tax return of each tax holder.
Unlike the old method in which the profits and losses will be taxed as income for the corporation before being taxed again as dividends after the shareholders are paid, it is not so. With the pass-through structure of S corp, the tax becomes more like a partnership or sole proprietorship.
This structure comes with some benefits for people with a low personal income tax, compared to the corporate tax rate. If your S corp profit passes through to you as a personal income, there is no state income tax payment on it. However, if it is corporate tax, there will be state corporate income tax.
Qualification of a Corporation for an S Corp Election
As juicy and enticing as an S corporation is, not every corporation qualifies. The first thing a corporation needs to do is examine Uncle Sam's standards. As a rule, giant firms and some types of financial institutions are not eligible.
For cooperation to qualify, they must
Be a domestic firm
The shareholders must be below 100
Contain allowable shareholders. These are some trusts, estates, and individuals. Corporate shareholders and partnerships don't apply.
Have a singular class of stock
Does not qualify for a type of corporation like insurance firms.
Majorly, closely held corporations qualify for S corp elections. In other words, the form will only have a few shareholders who take part and profit from the business. For firms that qualify for S corp, it is essential that they file Form 2553 within 75 days of the tax year or anytime in the tax year if they don’t mind it going into effect the coming tax year.
Disadvantages of S Corps
S corp might seem like an excellent and ideal legal entity for your firm. However, it doesn’t come without some cons. An S corp will have to follow the corporate governance rule strictly. There is a laid down rule on the corporation's structure to follow alongside the annual meetings and regulations guarding record keepings.
In terms of voting rights, or the allocation of losses and profits among shareholders, another disadvantage is the lack of flexibility. There is some flexibility with a traditional corporation since there can be various shares of stocks that could come with their unique right to profit, loss, and voting. An S corp, on the other hand, only enjoys a single type of stock. With this, sharing of profit and loss is similar the same way all shareholders get a vote.
Another con to be mindful of is that should any shareholder work for the corporation; the person needs to be paid reasonable compensation. If Uncle Sam assumes that you or any other shareholder is paid maybe too little or too much for the work done in the firm, Uncle Sam can re-qualify the wage, which could shoot up the taxes.
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