An S-corporation is for US federal income tax purposes. Oftentimes, it functions as a closely held corporation. But an S-corp can also operate as a partnership or LLC: limited liability company. An S-corp gets taxed through Subchapter S of Chapter 1 of the Internal Revenue Code. Each S-corporation never pays income taxes. Instead, the losses and income of the corporation get distributed to shareholders. Shareholders then have to report income or losses through individual tax returns. Please continue reading to learn more about how an S-corp functions. If you have any questions, feel free to give our organization a phone call.
What Are S-Corporations (S-Subchapters)?
Every S-corporation can also refer to an “S subchapter.” It is a form of corporation that adheres to certain IRS rules and regulations. The IRS has a series of Internal Revenue Code rules that corporations must follow. An S-corp can pass income to shareholders on a direct basis. (It can also pass deductions, losses, and credits.) This way, each S-corp will not have to pay federal corporate taxes. The average S-corporation benefits small businesses across the United States. These businesses feature fewer than one hundred shareholders. S-corp legal status matters. It provides a business with all the standard benefits of incorporation. Plus, the S-corp can receive tax-exempt privileges that a partnership also gets.
Here is how an S-corporation receives its official S-corp status from the government.
The corporation has to adhere to all the following rules. First, the S-corporation must function as a domestic corporation. It must also feature a class of certain shareholders. The S-corp can have certain trusts, estates, or individuals. Shareholders cannot operate as corporations, partnerships, or non-resident shareholders.
Each S-corp cannot feature more than one hundred shareholders.
Only one single class of stock applies to each S-corporation. Keep in mind that not all corporations have eligibility to become S-corporations. For example, some insurance companies and financial institutions are not eligible. Say that a corporation desires to become an official S-corporation. The corporation has to file Form 2553: Election by a Small Business Corporation. Then, the form will get signed by every shareholder.
The Basics of an S-Corporation & S-Subchapter
Say that a company wants to receive official S-corporation status. First, the business has to meet specific IRS rules and regulations. These include domestic incorporation policies. (The incorporation cannot take place outside of the United States.) The corporation must only have a single class of stock. Plus, the S-corporation cannot feature more than 100 shareholders. Each shareholder has to meet specific rules under US federal law. Sure, an individual can function as an S-corporation shareholder. But some trusts and estates can also operate as shareholders. Even some 501(c)(3) tax-exempt organizations can also function as shareholders.
So, where does an S-corporation get its name?
It comes from Subchapter S of the Internal Revenue Code. That is the same code that an S-corp elects to get taxed by the IRS. Here is a crucial characteristic of a corporation with a Subchapter S filing. It can pass losses, deductions, credits, and business income to shareholders. This takes place without the corporation having to pay any federal corporate tax. (That process refers to a pass-through entity.) An S-corp at the corporate level becomes liable for some taxes. This involves passive income and certain built-in gains taxes.
Each shareholder has to report corporation losses, gains, and income.
Those reports go within individual tax returns. Then, a shareholder pays taxes through his or her standard income tax rate. Money comes to shareholders without any corporate tax. As a result, shareholders can avoid double taxation on earnings and income.
Other than tax status, S-corporations function like any other corporation or C-corporation.
An S-corp is a for-profit company. It gets incorporated and governed by the same state’s official corporation laws. Again, S-corps and C-corps are not that different. They both provide the same type of liability protection. Plus, both entities feature the same management and ownership advantages. Each S-corp has to take part in specific formalities and internal practices. For example, an S-corp has to write corporate bylaws and feature a board of directors. An S-corp also holds shareholder meetings and logs minutes of company meetings.
What Is IRS Form 2553?
Are you planning on creating an S-corporation? If so, you must first incorporate your business. Say that you take care of incorporation. You then have to file Form 2553 through the IRS. The official title of the form is: “Election by a Small Business Corporation.” The form states the following message. The IRS only accepts S-corp status under the following condition. Your business has to meet every single rule and regulation of S-corp status. Plus, shareholders must sign a consent statement.
The Advantages of S-Corporations
There are many advantages associated with filling through Subchapter S. Here is the major advantage of registering your S-corp: the tax benefits. Through an S-corp, you will not need to pay federal taxes at an entity level. Of course, saving money on your corporate taxes is very beneficial. It matters even more when a business is starting out in its early years.
Here is another major advantage of having an S-corporation.
Official S-corp status almost always limits a business owner’s personal income tax. Say that money earned from a business gets characterized as dividends or salary. An S-corporation owner can lower his or her liability under self-employment tax. S-corp status also creates deductions related to wages paid to employees. Plus, S-corp status can also generate deductions through business expenses. How to get Business Licensing.
An S-corp shareholder can function as any company employee.
The shareholder receives corporate dividends and earns a salary. All corporate dividends can feature tax-free status. (As long as a distribution never exceeds a stock basis.) Say that dividends do exceed the stock basis of a shareholder. That means an excess gets taxed through capital gains. But the tax has a reduced rate compared to a standard income.
There are more advantages related to S-corporations.
One is that you can transfer interests and change the property basis. Say that you take one or both of these key actions. You will not have to face adverse tax consequences. Plus, you will not have to adhere to confusing accounting rules. Also, having S-corporation tax status can boost your credibility. But not only with employees and potential customers. This also applies to your investors and suppliers.
LLCs vs. S-Corps
An LLC is a limited liability company. It is a separate form of legal entity. Like an S-corp, LLCs are common structures for many small businesses in the US. S-corps and LLCs share many characteristics. They both function as pass-through entities. This means that neither legal entity has to pay corporate taxes. Plus, bth of them provide limited liability protection for principals and owners. This means that business creditors cannot seize the assets of a business owner. Also, an owner cannot get held responsible if a lawsuit gets filed against the business. How Long Does It Take To Get an LLC?
An LLC has more flexibility compared to an S-corp. LLCs never become subject to specific IRS regulations.
The regulations concern the type or number of both shareholders and owners. (Keep in mind that a “member” can refer to an owner or shareholder.) Plus, LLCs do not have to follow certain state or federal rules. These rules focus on procedure, governance, and the distribution of funds. Instead, an LLC can divide losses and profits based on what the owner wishes.
An LLC is much easier to create compared to an S-corporation.
Oftentimes, an LLC gets formed through a sole proprietor. Or, a small group of professionals, like doctors or lawyers, form the LLC. The financing options are more limited through an LLC compared to an S-corp. Here is an example of how this works. LLC owners focus on financing through bank loans instead of equity investors. As a result, the potential for growth of an LLC is more limited than that of an S-corp. The Best State for LLC.
An S-Corporation’s US Income Tax Returns
Almost all S-corporations remain exempt from having to pay corporate taxes. But each S-corp still has to report its earnings with the federal government. Plus, all S-corporations have to file tax returns with the IRS. An S-corp can use Form 1120-S as its tax return. The form often accompanies a Schedule K-1. The Schedule K-1 delineates a percentage of a company’s shares. This applies to every individual shareholder. Form 1120-S reports all losses, dividends and income. It refers to distributions that corporations pass over to shareholders.
A C-corp files tax returns each quarter.
Meanwhile, like individual taxpayers, an S-corp only files once per year. Form 1120-S is a simple tax form that C-corporations also use. Say that a business elects official S-corporation status. Then, the IRS accepts the election. The S-corp must then file Form 1120-S. The form’s due by the 15th day of the three month once the fiscal year concludes. In other words, most US companies with S-corp status must file taxes on March 15.
Why Elect a Business as an S-Corporation?
S-corporations function as the best of both worlds for all sorts of small businesses. An s-corp combines the tax advantages of partnerships with benefits of corporations. Each s-corp provides limited liability protection of its corporate structure. This means that the personal assets of an owner cannot get accused by business creditors. The concept also applies to any legal claims made against a company.
Like a partnership, an s-corp does not pay corporate taxes on generated income. Or, any corporate taxes related to business earnings. Having an S-corporation can also prevent an owner from having to pay a self-employment tax. The key is for the owner to make sure compensation gets structured as a stock dividend. Otherwise, an owner should structure compensation as an official salary.
What Does the “S” in S-Corporation Refer To?
The “S” in S-corp refers to Subchapter S of Chapter 1 within the Internal Revenue Code. An S-corp elects to get taxed through this specific provision inside the IRS code. Another common term for an S-corporation is an S-subchapter.
More Information About How an S-Corp Functions
In general, each s-corp functions in the same manner of a corporation. The s-corp operates within the corporation statutes of a home state. First, the s-corp establishes corporate officers and a board of directors. Next, the s-corp creates both a management structure and by-laws. Any s-corp can issue shares of the company’s stock. S-corp owners do not get held liable for claims against each company. Or, any legal claims that creditors make. What services do we provide?
S-corps never get taxed on the federal level for most distributed/generated earnings.
This leaves the corporations with more money to pass toward shareholders. All shareholders pay taxes on funds through standard income rates. Funds get allocated based on the number of shares that the shareholders have. Or, the equity stake status of shareholders. Each S-corp has to restrict its number of shareholders to one hundred or fewer.
A shareholder can operate as a trust, nonprofit, or an individual.
Both the corporation and stockholders must live and work in the United States. Let’s say that it is tax time. An S-corp has to provide shareholders with the Schedule K-1 form. The form states the annual losses and profits of the S-corporation. Ten, the shareholders file Form 1120-S through the IRS.
S-Corporation Policies in California
Keep the following information in mind if you’re considering forming a California S-corp. All S-corporations have to pay a specific franchise tax. The tax is 1.5% of net income within California. An s-corp has to pay at least $800 in the franchise tax. Keep that in mind if you’re deciding between forming an LLC or S-corporation.
Are LLCs Better Than S-Corps?
There is no “yes” or “no” answer to this question. It depends on the nature and size of your business. Plus, it comes down to the unique growth aspirations of your company. An LLC often works best for enterprises or sole proprietors with only a few partners. Why? Because of the flexible nature of LLCs. Also, there is an ease of establishment.
Now, say that your business is either large or you want it to become large.
Establishing an S-corp might work in your favor. One key reason is that S-corps have many financing options. Unlike an LLC, an S-corp can provide equity stakes to investors. This way, a return for capital can take place. Say that business operations involve many different complexities. A business could benefit by establishing formal compliance procedures and structure.
The Difference Between C-Corps & S-Corps
A key difference between C-corps and S-corps comes down to one word: taxes. In most cases, C-corps pay taxes and S-corps do not. But keep in mind that C-corps do pay corporate taxes on all earnings. The payment system is like when individuals pay the IRS through income taxes. Dividends and other profits get disturbed toward the shareholders. This takes place through after-tax funds. In contrast, S-corps receive an expedition from federal tax. That exemption applies to almost all earnings. Some exceptions do exist within some passive income and capital gains. Through an S-corporation, you can distribute gains to stockholders with ease.
Remember that all S-corps do face specific restrictions mandated by the IRS. All shareholders must operate within the United States. An S-corp cannot feature more than one hundred shareholders. The ranks of shareholders become limited to the following entities. They are: estates, nonprofits, trusts, and individuals. An institutional investor cannot operate as a shareholder of an S-corporation. Each S-corporation can only issue one single class of stock. Meanwhile, C-corps do not have to adhere to any of these restrictions. Also, in most cases, a C-corp is larger than an S-corp.
You Can Experience Liability Protection Through an S-Corporation
Sure, S-corporations feature many major tax advantages. But they also have the exact protection from liability as any corporation’s status. Think of it this way. An s-corp maintains an independent life from its owner. This means situations like key shareholders departing is not a big deal. The benefit of flexibility leads to an ease in transferring ownership of a business. It can take place through a gradual or outright sale. But most S-corporations do have some transfer restrictions.
Keep in mind that S-corporation taxation is not only for a corporation. Many LLCs in the US can also elect to get taxed like an S-corp. Otherwise, an LLC gets taxed as a partnership or a sole proprietorship. This means that the IRS considers each owner self-employed. As a result, the owner has to pay a self-employment tax related to business profits. Any S-corp shareholder can serve as a company employee. This way, a report of distributions from company profits and salary takes place. Distribution income is never subject to self-employment taxes for S-corp shareholders.
Questions About Forming or Maintaining an S-Corporation? Call Us Now
Do you have any questions related to S-corporations? If so, feel free to pick up the phone and call our organization. The LegalRegistration.com team is standing by to assist. You can also direct your questions via email or a message right here on our website. We look forward to helping you form or maintain your S-corporation.