An important choice that every business owner must make is how to classify their business. There are a number of different business entities to choose from, such as a Limited Liability Company (LLC), Sole Proprietorship, and S-Corporation.
An S-Corporation, also known as an S-Corp or Subchapter S corporation, is a flexible option for individuals or shareholders wanting to create a corporation. This business structure allows shareholders to avoid certain taxes and save money. This corporation type also offers helpful protections including pass-through status and limited liability. Shareholders play an essential part in the development and growth of S-Corps. Consider the following benefits and drawbacks of an S-Corp.
What Is an S-Corp?
For your business to be classified as an S-Corporation for tax purposes under the Internal Revenue Code, your business must meet the Internal Revenue Service (IRS) criteria:
The following types of corporations are ineligible:
To register your business as an S-Corp, you must submit Form 2553, Election by a Small Business Corporation, signed by all the shareholders.
What Are the Benefits of an S-Corp?
There are several benefits to consider if you’re interested in forming an S-Corp including:
Can You Pay Yourself a Salary in an S-Corp?
S-Corp owners must pay themselves a reasonable salary. A "reasonable salary" can vary, but it is the equivalent of what employees in your industry earn for similar work. To determine a reasonable salary for yourself and your shareholders, think about:
What Are the Downsides to an S-Corp?
There are a few downsides to consider if you’re interested in an S-Corp. First, this business structure required to file both federal and state taxes. This includes Articles of Incorporation and corporate minutes. You’ll also hold regular shareholder meetings and pay required government fees if you form an S-Corp.
There are also shareholder restrictions to consider. Shareholders pay taxes on income that the S-Corp receives, even if the shareholder didn’t receive any of the revenue. Finally, the Internal Revenue Service (IRS) requires each business owner and officer of an S-Corp to make a salary, even if the company has yet to make a profit.
What Else Should I Know?
As an S-Corp, your corporation can avoid double taxation. S-Corps are pass-through tax entities, meaning that the corporation isn't taxed on its profits. Profits passed onto shareholders are taxed as personal income.
Shareholders can receive dividends - the remaining profits after paying expenses. Shareholders do not have to pay a self-employment tax on these earnings.
Since S-Corp shareholders are employees, any earnings are subject to the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA). You must withhold some of your income for federal income taxes and report any earnings on your and the shareholders' personal income tax.
It is possible to operate an S-Corp as an independent contractor instead of an employee. If this is the case for you, you'll fill out a W-9 and pay a self-employment tax of 15.3%.
Finally, to form your S-Corp, you'll need to:
How to Pick the Best Business Entity For You
Choosing the right business entity is a critical decision that can impact your business's legal structure, taxation, liability, and growth potential. Let's dive into the differences between S-Corps, LLCs, and C-Corps.
S Corps vs. LLCs
Both an S-Corporation and a Limited Liability Company (LLC) offer limited liability protection and pass-through taxation, however, there are some differences:
S Corps vs. C Corps
Both S-Corps and C-Corps offer limited liability protection and are separate legal entities with their own tax identification numbers. With that being said, there are some differences to be aware of:
Work with the Professionals
S-Corps offer advantages to owners and shareholders that ensure success. While beneficial, the process can lead to confusion, and you may need answers or clarification. It may be helpful to work with a small business tax accountant if you are unsure of the S-Corp application and formation process. An accountant will assist you through the S-Corp process. Don’t hesitate to seek advice from the experts to guide your corporation through this global crisis.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.