Corporations that meet certain requirements can elect an s corporation status with the IRS. This federal tax status enables companies to “pass through” their taxable income or losses to owners/investors in the business, according to their ownership stake in the business. By default, companies that do not specify a tax status with the IRS are considered to be c corporations – which means that they will be taxed as a c corporation.
On the other hand, by electing s corporation status, a corporation can eliminate the disadvantage of “double taxation” of corporate income and shareholder dividends associated with the c corporation tax status.
The cost of a s corp can vary. Say a corporation makes $300,000 in a given year – if it is an s corporation, the business itself will not be taxed for that amount; instead, the company’s shareholders will be required to pay taxes according to their share of the company. In this scenario, if the company has three shareholders, each with an equal share of company stock, each shareholder will pay taxes on $100,000.
If the c corporation makes $300,000 in a year, then the company would pay taxes at the current federal corporate tax rate of about 34%. If the remaining profits of $198,000 are distributed to the three shareholders as dividends, each shareholder will pay taxes on $66,000 in dividend income at the current federal dividend tax rate of 15%.
S corporations, like other types of corporate entities, also keep owners’ personal assets safe from company debt and judgments against the business.
In short, the s corporation status offers the following advantages:
- Limited liability: Company directors, officers, shareholders, and employees enjoy limited liability protection. One of the main advantages of incorporating is that the owners’ personal assets are protected from creditors of the corporation. For instance, if a court judgment is entered against your corporation saying that it owes a creditor $500,000, you can’t be forced to use personal assets, such as your house, to pay the debt. Because only corporate assets need be used to pay business debts, you stand to lose only the money that you’ve invested in the corporation.
- Pass-through taxation: Owners report their share of profit and loss on their individual tax returns. In general, S corporations do not pay any federal income taxes. Instead, the corporation’s income or losses are divided among and passed through to its shareholders. The shareholders must then report the income or loss on their own individual income tax returns.
- Elimination of double taxation of income: Income is not taxed twice; once as corporate income (profits) and again as individual dividend income.
- Investment opportunities: The company can attract investors through issuing shares of stock. In certain situations, equity financing is more advantageous than debt financing.
- Perpetual existence: The business continues to exist even if the owner leaves or dies, transfer of ownership is also easier in most cases.
- Once-a-year tax filing requirement (vs. quarterly for a c corporation)
We can help.
If you have not already formed a corporation, we can help you form your new s corporation in any state. We can also provide you with the forms necessary to elect S Corporation status with the IRS. Please note that we do not complete or file the Subchapter S application with the IRS, but our complete formation package does include the required IRS form 2553.
You should be aware that there are certain restrictions on the number and citizenship of shareholders of an S Corporation and that certain other requirements are imposed on s corporations. You may wish to consult with professionals such as attorneys or tax advisors to determine whether an S Corporation is the best option for your company.
It’s very important to note that in order to elect an S Corporation status, after your company has been formed, you must file the s corporation form 2553, “Election By a Small Business Corporation.” Timing is critical with IRS form 2553 – it must be filed within 75 days of your corporation formation or LLC’s anniversary of formation, or within 75 days of a new year. When you form your s corporation with us, form 2553 is provided to you with your formation package.