S Corporations

Choosing the form of business you will be operating under is the second most important decision you can make, the first being actually going into business.

 I believe that operating your business as a Sub Chapter S or Small Business Corporation makes sense.  In fact five businesses I own are operated as Sub Chapter S Corporations. I am not alone in this belief.  This year of the 4,000,000 corporate income tax returns that will be filed with the Internal Revenue Service, more than 2,000,000 will be Sub Chapter S Corporation returns.

Take a minute to read the discussions from a variety of experts.  Then if you believe that becoming an S Corporation makes sense, call us.   

We will make an appointment to visit with you to discuss your individual situation.

Pros and Cons of an S Corporation

Deciding what type of business company structure is best for your small business can be a confusing exercise. Is an S Corporation advantageous for your small business?

Learn the pros and cons of becoming an S Corporation.

What is an S Corporation?

An S Corporation (Small Business Corporation) is a business elected for S Corporation Status through the IRS. This status allows the taxation of the company to be similar to a partnership or sole proprietor as opposed to paying taxes based on a corporate tax structure.

Pros of S Corporation Status

No Corporate Tax: The biggest attraction of this business ownership is the tax advantages. The profits and losses of the business pass through to the corporation owner's personal income tax. Like a Limited Liability Company, the tax "pass through" allows you to avoid "double taxation".

Reduce Taxable Gains: Selling your business can be part of your retirement strategy.

Write off Start-up Losses: In the early years of starting a business, you will have many expenses and losses. These can be offset against your personal income. A regular corporation would have the losses locked within the company and not applied to your income.

Liability Protection: S corporations offer protection against liabilities. However, liability protection is not complete protection. You can be personal liable for your actions. As well as, many lenders are now requiring personal guarantees.

Cons of S Corporation Status

One Class of Stock: Choosing an S Corporation status will limit your organization to issuing one class of stock. Not having the ability to issue different classes of stock affords a business less control over the company and limitations on the stock value.

Less Attraction for Outside Investors: Growing your company requires money. If you will need venture capital, the regular corporation structure will be a better choice. Venture capitalists will not want to see the pass through tax setup or a limit of 75 shareholders.

Tax Filing: Unlike a non-corporate business structure, you avoid corporate taxes but will still have to file a tax return every year.

Corporate Meetings: Your status is still a corporation with the requirements of having regular meetings and maintaining company minutes. Consider the added time in operating an S Corporation.

How to Form an S Corporation

To change your corporation status requires the filing of Form 2553 with the IRS. To become a small business corporation, the IRS has several special requirements including:

The corporation can have no more than 75 shareholders with a husband and wife counting as one shareholder. (Before 1997 it was 35 shareholders)

Shareholders can be individuals, estates, and certain trusts.

Shareholders cannot be non-American residents.

You must be a domestic company in any state.

 All shareholders must agree to the S Corporation structure formation.

Making the decision on the best business structure for your situation is never easy. This article should provide you with the basics of S Corporation status and help guide your decision of company business formation. Each state's laws differ as well as each company's situation. It's advisable to seek tax and legal counsel to determine the best choice for your individual circumstance.

Darrell Zahorsky

                                   

Self-Employment Tax Savings

Corporate profits are not subject to Social Security, Medicare, Workers Compensation and other taxes - a combined 15.3% in taxes. An individual proprietor would need to pay all of the foregoing taxes (commonly referred to as “self-employment taxes”) on all income earned by the business. With a corporation, only salaries are subject to these taxes.

For example, if a sole proprietor earned $60,000 from the business, a 15.3% tax would have to be paid on $60,000. Let's assume that the owner of a corporation pays himself or herself $40,000 a year in salary, and $20,000 is left over as corporate profits. In this case, the 15.3% tax would only be paid on the salary ($40,000). This saves the owner of the corporation over $3,000 per year!

Please note that a stockholder-employee must pay himself or herself a reasonable salary, or else the IRS could re-characterize some or all of the corporate profits as salary. Brian Liu, Esq.

S Corporation Basics

This type of corporation can be great for small businesses because it eliminates the double taxation of standard corporations. June 01, 2005

    

The S corporation is often more attractive to small-business owners than a standard (or C) corporation. That's because an S corporation has some appealing tax benefits and still provides business owners with the liability protection of a corporation. With an S Corporation, income and losses are passed through to shareholders and included on their individual tax returns. As a result, there's just one level of federal tax to pay.

A corporation must meet certain conditions to be eligible for a subchapter S election. First, the corporation must have no more than 75 shareholders. In calculating the 75-shareholder limit, a husband and wife count as one shareholder. Also, only the following entities may be shareholders: individuals, estates, certain trusts, certain partnerships, tax-exempt charitable organizations, and other S corporations (but only if the other S corporation is the sole shareholder).

In addition, owners of S corporations who don't have inventory can use the cash method of accounting, which is simpler than the accrual method. Under this method, income is taxable when received and expenses are deductible when paid.

S corporations do come with some downsides. For example, S corporations are subject to make of the same requirements corporations must follow, and that means higher legal and tax service costs. They also must file articles of incorporation, hold directors and shareholders meetings, keep corporate minutes, and allow shareholders to vote on major corporate decisions. The legal and accounting costs of setting up an S corporation is also similar to those for a standard corporation. And S corporations can only issue common stock, which can hamper capital-raising efforts.

Gaining--and Revoking--S Status

A corporation must make the subchapter S election no later than two months and 15 days after the first day of the taxable year to elect. Subchapter S election requires the consent of all shareholders.

The states treat S corporations differently. Some states disregard subchapter S status entirely, offering no tax break at all. Other states honor the federal election automatically. Finally, some states require the filing of a state-specific form to complete subchapter S election. Consult an attorney in your state to determine the rules that apply to your business.

An S corporation may revoke its subchapter S status by either failing to meet the conditions of eligibility for S corporations, or by filing with the IRS no later than two months and 15 days after the first day of the taxable year. Once the revocation becomes effective, the business will be taxed as a corporation.

S Corporations vs. LLCs

S corporations and LLCs possess similarities: They offer their owners limited liability protection and are both pass-through tax entities. Pass-through taxation allows the income or loss generated by the business to be reflected on the personal income tax return of the owners. This special tax status eliminates any possibility of double taxation for S corporations and LLCs.

That's where the similarities end. The ownership of an S corporation is restricted to no more than 75 shareholders, whereas an LLC can have an unlimited number of members (owners). And while an S corporation can't have non-U.S. citizens as shareholders, an LLC can. In addition, S corporations cannot be owned by C corporations, other S corporations, many trusts, LLCs or partnerships. LLCs are not subject to these restrictions.

LLCs are also more flexible in distributing profits than S corporations, wherein the corporation can only have one class of stock and your percentage of ownership determines the percentage of pass-through income. On the other hand, an LLC can have many different classes of interest, and the percentage of pass-through income is not tied to ownership percentage. The pass-through percentage can be set by agreement of the members in the LLC's operating agreement.

S corporations aren't without their advantages, however. One person can form an S corporation, while in a few states at least two people are required to form an LLC. Existence is perpetual for S corporations. Conversely, LLCs typically have limited life spans.

The stock of S corporations is freely transferable, while the interest (ownership) of LLCs is not. This free transferability of interest means the shareholders of S corporations are able to sell their interest without obtaining the approval of the other shareholders. In contrast, member of LLCs would need the approval of the other members in order to sell their interest. Lastly, S corporations may be advantageous in terms of self-employment taxes in comparison to LLCs.

This article was excerpted from the books Start Your Own Business and Entrepreneur Magazine's Ultimate Book on Forming Corporations, LLC's, Sole Proprietorships and Partnerships, and the article "S Corporations Vs. LLCs" by Rick Oster