S Corporations are considered to be the most prevalent type of corporation with entrepreneurs and the most popular in the United States, with tax year 2003 reporting that 61.9% of all corporations filing Form 1120S were shown to apply for S Corp status. What is it about this entity that makes it so popular with small businesses, anyway? Much of that answer actually has to do with the double taxation that comes with incorporating a business. Once a business has been incorporated, it must pay a tax on the income that it earns – along with tax on the income you earn from working for the corporation.
This is what is known as double taxation, a.k.a. the same amount of income taxed twice that few (if any!) small business owners are prepared for or want to pay. Filing for S Corporation status helps nip double taxation in the bud and also provides great benefits for small businesses. Here’s a look at a few of our favorite incentives underneath this legal structure.
How S Corporations work with double taxation
We briefly mentioned that filing for an S Corp allows small businesses to get around double taxation, but didn’t provide more information as to how that process works. When an S Corp is formed, the entity is telling the federal government that it would like to be taxed as a partnership and not as a corporation. Instead of paying federal income taxes at a corporate level, S Corps elect to have their profits, losses, deductions, and credits passed through to your personal tax return. This is what is known as a pass-through structure. In the case of the S Corp, it only taxes the company’s shareholders. One detail to keep in mind is that said shareholders must be paid “reasonable compensation,” otherwise additional corporate earnings may be classified as wages by the IRS.
Not every business can become an S Corp
There’s something to be said about the appeal of an exclusive entity — if you want to file as an S Corp, here’s a look at the certain requirements you need to meet first to see if you qualify as one:
- Be based out of the United States and filed as a U.S. corporation.
- Maintain a maximum of 100 shareholders.
- Issue only one class of stock.
- Be comprised solely of shareholders who are individuals, estates, or certain qualified trusts. Shareholders must have a U.S. Social Security Number and consent in writing to the S Corp election.
Enjoy tax savings and credits
The U.S. Small Business Administration notes that unlike an LLC in which the members are subject to employment tax on the entire income of the business, only the wages of an S Corp shareholder who is an employee is subject to employment tax. All of the remaining income goes to the owner as a distribution, which means big tax savings for both the small business and its owner — you!
Additionally, employees that own 2% or more shares within an S Corp enjoy tax credits. Health and life insurance, for example, are two benefits that can be considered taxable income and written off as business expenses.
S Corps look after their owners and the business
No, really — they do. By filing as an S Corp, businesses gain credibility, shareholders are provided with protection for their personal assets, and the business itself gets a taste of independence. Even if a shareholder leaves, the business will still be maintained as a distinct corporate entity and will be able to keep conducting business as usual without any hiccups along the way.
NOTE: This guest blog post was authored by Deborah Sweeney and is published with permission. Deborah is the CEO of MyCorporation.com, which provides online legal filing services for entrepreneurs and businesses, startup bundles that include corporation and LLC formation, registered agent services, DBAs, and trademark and copyright filing services. You can find MyCorporation on Twitter at @MyCorporation and Deborah at @deborahsweeney.