Do you want to incorporate a business? You have the knowledge of sole proprietorships, partnerships, and a limited liability company and now you want to know if you should become an S corp. There are two major types of corporations that you can start; and S corporation or a C corporation. Understanding the benefits and costs, as well as how to start an s corp can help put develop your business and reach the next level of success.
What is a S Corporation
S corporations are seen as small business corporations. They are made for smaller developing businesses that want to improve their reach and receive the benefits of incorporation. The rules of s corporations are found in Sub-chapter S of the first chapter of the Internal Revenue Code, first passed in 1946. Similarly to partnerships, income, deductions, and tax credits flow from the business to the shareholders, regardless of whether the distributions were made. This means that the taxation comes at the shareholder level, rather than the corporate level. While it only offers one class of stock, it is seen as the best option for a smaller business.
Like a c corporation, s corporations have all the benefits of incorporating such as the investment opportunities, existence past the life of the owners, and of course, limited liability. The major difference between an s corp and a c corp is the tax benefits. S corps only have to file taxes once per year and are not subject to the double taxation that is undertaken by a c corp. S corps are usually seen as the more friendly and easier version of a C corporations and have numerous advantages and disadvantages that need to be understood before you make your incorporation decision.
Benefits of S Corps
Aside from the usual benefits of a corporation, it is important to know all of the reasons to get involved in becoming an s corporation. The most obvious benefit of all corporations is limited liability. To easily understand limited liability, it is just the promise that the financial liability of officers, directors, and shareholders are limited to a fixed value. This prevents people from losing all of their personal assets if the business were to fail or suffer extreme losses.
Another benefit is what is called pass through taxation. All owners report their own share of losses and profits in their personal tax returns. This is important because it prevents double taxation. Usually, the business would be taxed on these numbers, then the owners would be taxed on their earnings after the initial taxes. Income from the company is also not taxed twice. An owner in an c corporation would have their income taxed first as corporate income then again as dividend income.
S corporations also receive the benefit of the potential for investors. The business is able to use the sale of stock to entice investors and help the business grow. The is essential for a business’s long term survival and success. The more people who are able to invest will cause some dilution of the initial shares, but everyone will realize profits on dividends, if the corporation chooses to pay them out.
Unlike a sole proprietorship or a partnership, corporations enjoy the protection of their existence past the life of the owners. In the former types of business, the business only survives as long as the owners are still alive. Corporations have a perpetual existence that lasts longer than all of its shareholders, as long as it makes money of course.
The final major benefit of s corporations over c corporation is the yearly tax filing. C corporations are required to file taxes quarterly. This means that s corps only have to make these payments once per year and all of the accounting and prepwork only has to be done once, rather than four separate times. This cuts down on the burden of smaller businesses needed to file their taxes less frequently.
Disadvantages of S Corporations
It is easy to be blinded by the benefits of s corps, but it is important to understand the drawbacks to properly evaluate if you are prepared for the incorporation process. Most notably, s corps can only be started by U.S. citizens and permanent residents. People who do not fall under this category are still able to created LLCs and C corporations.
C corps also have a limited number of owners. Unlike a C corporation, they may not have more than 100 different shareholders. This means that there is a cap on investment opportunities. Obviously, this can be overlooked if you plan for the number of owners to remain small, such as with friends and family. If you are looking for many investors to back your product, it is important to keep this limited number in mind.
The burden of creating a corporation is still present with c corps. This burden includes creating Articles of Incorporation for your business. This, and other filings must be made with your state to ensure that the business has been incorporated properly. Additionally, a registered agent needs to be appointed to your company and all fees must be paid. In several states, these fees are recurring throughout the life of your company and can be costly over time. Some states even include annual reporting fees and franchise tax fees. These fees can be a barrier to entry for many and should be fully understood, along with the red tape and filings required, before beginning the incorporation process.
There are also tax qualification obligations associated with s corporations. As previously mentioned, there are an obscene amount of filings that must be done with the state to keep up the incorporation. A single mistake regarding the filings of the incorporation can actually result in the termination of the entire corporation. This is a tremendous burden and it needs to be taken into account and any possible owners should consider having a team in place to ensure proper filing.
In addition to the required filings, there is typically additional scrutiny from the IRS against s corps. All payments made to employees and shareholders could be classified as either salaries or dividends and this can create issues in filing. This is because each class is taxed differently, which draws more watchful and careful eyes from the IRS. As before, a team dedicated to this distributions and filings can make this process even easier.
A unique disadvantage of s corporations is that all of the shareholders must be individuals. Some eligible businesses are allowed to become shareholders but it is widely accepted that only individuals can become shareholders of s corporations.
Some of these disadvantages are the same disadvantages that are seen with C corporations. As a business person, you understand the value of risk vs reward. Incorporation has its own risks, but since you are at this step in the process, you should not be dissuaded by the red tape and fees. These are simply factors and obstacles on your business’s road to incorporation.
Start Your S-Corporation for as low as $49 + State Fee
Start Your S-Corporation for as low as $49 + State Fee
How to start S corporations
The process of starting s corps should be undertaken carefully in order to make sure the business is set on a solid foundation. The first step, a step that you likely have already achieved, is by choosing a name for your business. You will have to file this name with the Secretary of State. If your name has already been taken by another business, or it is too similar to another name in the state, then you may be asked to make changes to the name. Once your business name has been accepted, you can move on to the next step in the process.
The most important part of the process for your business is drafting your Articles of Incorporation. This document will outline all the pillars of your company. Articles of Incorporation typically contain the business name, the agent of the business, purpose of the business, duration of the business, authorized shares, property and gross revenue, as well as the names and addresses of all the directors of the company. Once this document has been drafted it must be filed with the Secretary of State and approved.
Once your paperwork has been filed, your business will then issue stock certificates to all the initial shareholders. As previously mentioned, these stocks may be diluted when more shareholders arrive. These issuances and shareholders should be properly outlined in your Articles of Incorporation and followed exactly as planned. Any changes should be reflected in an updated form with the Secretary of State.
The next step is to obtain a business license as well as other certifications needed in your industry. Research can indicate all of the necessary certifications that must be obtained by businesses in your state of the same type. Simultaneously, you should file a form SS-4 with the IRS or apply online to receive your unique Employer Identification Number (EIN). At this point, it is important to research any other types of identification that are required by your county/city/state. Tax IDs will be required for payments such as disability, unemployment, and payroll taxes.
Once all of the following have been completed and you have received the news that the corporation has been properly formed, the last step is to file IRS form 2553. This form must be filled out and filed within 75 days of corporate formation to avoid any taxes or penalties.
Maintaining S Corporations
Once the filings are completed and fees are paid, there is still some maintenance to be done to keep up with the legal requirement of acting like a corporation. A corporation must have certain characteristics in order to keep up their status.
There need to be regularly scheduled meetings of both the shareholders and directors. The director’s meetings can be done monthly, bi-monthly, and quarterly in most cases. No matter the frequency, it must remain frequent and minutes/record must be kept of all the meetings. These minutes are usually kept by an appointed secretary and are kept by the same person at each meeting. There also must be a record of the official company bylaws, this is to make sure the shareholders and employees know what is expected of them.
As a whole, all major business operations should be recorded and kept as detailed records for future review. S corporations require bookkeeping and accounting under GAAP (Generally Accepted Accounting Principles). This may add a cost to the business but it is important to keep a qualified and informed accountant. Many corporations will hire an attorney to evaluate the corporation frequently to make sure the business is being run according to state laws.
A: Names must typically end with "incorporated" or "corporation. Additionally, the name can not intentionally mislead the public. Usually, you are allowed to submit alternate name in order to speed up the process if your first name is ruled ineligible. If the name is approved, you may want to obtain trademark protection.
A: Yes, this is the person who will receive all correspondence from the state and county. Most states require either
(1) an adult living within the state or
(2) a corporation with a business location in the state.
A: You do not need an attorney to properly form your corporations. The more complicated your business and its operations, it may be helpful to enlist an attorney as they have experience with the incorporation process.
A: No, you may even be a sole shareholder. S corps are limited to 100 shareholders, but there is no limit or minimum for the number of shareholders.
A: You may incorporate in all of the 50 states. Many choose to incorporate in their home state, but there is a significant number that choose to incorporate in other states such as Delaware and New York due to their laws being perceived as more business friendly.