An S” class corporation is a type of alternative corporation, whose existence can be traced to Chapter 1 Subsection S of the IRS Code. In simple terms, an S corporation is one that, for purposes of federal taxation, does not pay taxes directly to the IRS but through its members and shareholders. Essentially, income, losses, deductions, and tax credits are passed on to the members, while it still enjoys the benefits of limited liability protection and no double taxation since the business income has already been taxed.
To be able to qualify for this designation, a business must:
- Be domiciled within the United States
- The number of shareholders cannot exceed 100, and cannot include corporations or non-resident members
- There is only one class of stock allowed to be issued
- Submitted the necessary documents for incorporation like Articles and Certificate of incorporation, along with the attendant fees
- Not have any other defaults which may have prevented it from being ordinarily registered as a business in the United States
- Submit Form 2553, duly signed with the IRS
Election for S corporation for Businesses
An S corp can either become an LLC or a C corp. The bottom line is, this election is done for tax advantage purposes and does not have a significant impact on the personal liability protections that are a natural incidence of forming an LLC or corporation.
Shareholders or members of an S corp can claim operational losses as a deduction on their income liability if the business fails to turn a profit and the proceeds are shared between the members.
The profits are only taxed once, so owners can avoid double taxation on personal income and dividends.
Also, an S corp is exempt from certain capital gains and side incomes at the federal level. Since it is essentially seen as a partnership, taxes are not paid at the corporate level but the personal income level so the owners can take advantage of these deductions.
However, it is still imperative to understand the nuances behind his legal and tax creation before delivering fully into it, as there are still limitations that the various laws put on S corps. A lot of these advantages may not apply in various states, as different states and municipalities have different tax regulations.
Advantages of an S Corp
Self-Employment Tax
A big advantage of electing to be an S corp is low self-employment taxes, as it is only salaries that are taxed, not distributed dividends. This is against other forms of businesses where the entire net business profit is taxable, thereby increasing the overall tax burden.
A separate and different entity from the owners
An S corp enjoys the added advantage of being taxed like a partnership, but not existing like one, or having the corporate structure of a partnership. So, an S corp is still independent of its owners and takes on a life of its own. In this regard, the exit or entry of members does not determine their corporate existence.
This also extends to the fact that the assets of the owners and shareholders are also distinct from that of the company. So, no member or shareholder can be held personally liable for the operational debts of the company, and cannot be made to surrender his assets in fulfillment of such liabilities, unlike a partnership or a sole proprietorship.
Cons of an S corp
The regulatory procedure of doing business
S corps have to follow laid down rules of doing business as set down by the company laws and tax regulations. They have to keep and maintain proper records, appoint key company officers such as secretaries and directors under laid down rules, keep accurate records of meetings, company regulations, and so on. They can be very stringently enforced by the regulatory agencies in many instances.
In many instances, this will require the help of a certified professional to ensure everything is done by the books, which can drum up operating costs due to professional fees. Professionals that may be required include bankers, tax consultants, lawyers, accountants, and other public sector experts to always ensure you remain in the books in your dealings.
It is always better to be safe than sorry when doing business, and if you elect to become an S corp these regulations should always be top of mind. Hiring a professional CPA firm can go a long way in mitigating these risks. When you are thinking of hiring a professional firm, you can file S corp online using Taxfyle, as it is recommended for a smooth and seamless compliance process.
Other constraints
There are many other regulatory and procedural bottlenecks associated with S corps. For example, according to IRS laid down regulations, certain people are exempt from being shareholders and members of S crops.
This will include artificial and natural persons. Artificial persons like corporations and partnerships cannot be a shareholder of an S corp, which ultimately limits its investment pool.
Also, foreigners and aliens cannot be shareholders and laid down guidelines dictate that a shareholder of an S corp must be an American citizen or a permanent resident. This is even so during the transfer of ownership by members or shareholders,
Regulations like this are a big hindrance to the flexibility and ease of doing business for S corps, it means they have to do a lot of background checking and the capital pool is quite limited. Noncompliance may effectively lead to being stripped of being an S corp. Another big limitation is the restriction of the class of stocks. This is a great disadvantage and allows for limited flexibility regarding capital allocation. Finally, an S corp may not have more than 100 shareholders, which can be problematic when trying to raise needed capital.
Conclusion
An S corp allows for features like limited liability, no double taxation, lower tax bills, and longevity beyond its shareholders, this is why it is the preferred structure for millions of businesses in the US. Members can also rest assured that their assets cannot be used to offset company liabilities and the business will continue in the event of loss of any shareholders. It may have its downsides, but overall an S corp can be a very good choice for business in the United States.
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