Starting a new business can be overwhelming for business owners who aren’t sure about which business structure to choose. Each type of business entity offers different benefits, so it’s important to know which one is best for you and your business.
Our informative guide will tell you if an S-corporation is the right small business structure for you.
Incorporating as an S-Corporation
If you want to incorporate a business, and you have the knowledge of sole proprietorships, partnerships, and limited liability companies, perhaps you’re considering if an S-corporation is the right small business structure for your business.
There are two major types of corporations that you can start— an S-corporation or a C-corporation. Understanding the benefits and costs, as well as how to start an S-corporation, can help you develop your business and reach the next level of success.
What is an 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-corps are found in Subchapter S-corporation of the first chapter of the Internal Revenue Code, first passed in 1946.
Similar to partnerships, income, deductions, and tax credits flow from the business to the shareholders, regardless of whether the distributions were made. This means that for a small business corporation, taxation comes at the shareholder level, rather than the corporate level for losses, deductions, and credits. While it only offers one class of stock, the one class of stock is still seen as the best option for small business owners.
What is the Difference Between an S-Corporation and a C-Corporation?
Like a C-corporation, an S-corporation also has all the benefits of incorporating beyond self-employment or sole-proprietorship. These benefits include investment opportunities as well as the limited liability protection offered to the business owner. The major difference between an S-corp and C-corp is the tax benefits offered to the company.
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 C corporations and have numerous advantages and disadvantages that need to be understood before you make your incorporation decision.
What are the Benefits of an S-Corporation?
Aside from the usual benefits of a corporation, the most obvious benefit is the limited liability protection. Limited liability protection guarantees that the financial liability of officers, directors, and shareholders is limited to a fixed value. This prevents people from losing all of their personal assets if the company were to fail or suffer extreme losses.
Another benefit is pass-through taxation. All owners report their own share of losses and profits in their individual tax returns, which prevents double taxation. Typically, the company would be taxed on these numbers, then the business owners would also be taxed on their earnings. An owner of a C-corporation would have their income taxed first by the IRS as corporate income then again as dividend income.
S-corps also receive the benefit of the potential for investors. The business is able to use the sale of stocks to entice investors and help the company grow. The more people who invest will cause some dilution of the initial shares, but everyone will realize the profits on dividends, which is a benefit for an S-corporation shareholder.
Another benefit is the yearly tax filing with the Internal Revenue Service (IRS). C-corporations are required to file taxes quarterly, but an S-corporation only requires the company to fulfill annual filing requirements with the IRS. This means that the owner only needs to worry about the accounting and prep-work once a year.
Start Your S-Corporation for as low as $49 + State Fee
Start Your S-Corporation for as low as $49 + State Fee
What are the Disadvantages of an S-Corporation?
It is easy to be blinded by the benefits, but you must also understand the drawbacks to properly evaluate if an S-corp is right for you. Most notably, the S-corporation status can only be achieved by U.S. citizens and permanent residents, but others are still able to create an LLC or C-corporation.
S-corps also have a limited number of owners and corporation shareholders. Unlike a C-corp, an S-corp cannot have more than 100 shareholders. There is a cap on investment opportunities once you obtain S-corporation status, whereas C-corps do not have that cap. If you are looking for many investors to back your small business corporation, it is important to keep this limited number in mind.
Contact LLC Formations for more information about how each structure can work for you.
What are the Requirements to Obtain S-Corporation Status?
Creating a corporation requires a few steps whether you register as an S-corp or C-corp. You must create the Articles of Incorporation to obtain corporation status. Similar to the requirement for a limited liability company, you need to file the Articles of Incorporation information with the state in order to be registered as an S-corporation.
To obtain S-corporation status, you will also need to appoint a registered agent to your company and you must pay the appropriate fees. In several states, these fees can be reoccurring and costly over time. Some states even require annual reporting fees and franchise tax fees. It’s important to be aware of the fees your corporation may be responsible for once receiving S-corp status.
There are also tax obligations associated with S-corporations and maintaining corporation status. A single mistake or missed information can result in the termination of the entire corporation and loss of corp status.
What are the Tax Obligations of an S-Corporation?
In addition to the required filings, there is typically additional scrutiny from the IRS against S-corps. All payments made to employees and S-corporation shareholders could be classified as either salaries or dividends, which can create issues in S-corp filings. This is because each class is taxed at a different tax rate, which draws more watchful and careful eyes from the IRS.
S-corporations are a unique structure because shareholders must be individuals who file individual income tax returns. Although some eligible businesses can become shareholders, typically only individuals can become shareholders of S-corporations.
How to Start an S-Corporation
Step 1 is to choose a name for your business and file the 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.
Next, you will draft your Articles of Incorporation for your company. The Articles of Incorporation typically contains the business name, the registered agent, the 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. This document also gets sent to the Secretary of State for approval.
Once your paperwork has been filed, your business will then issue stock certificates to all the initial shareholders. These shareholders should be properly outlined in your Articles of Incorporation, and any changes should be reflected in an updated form with the Secretary of State.
It is important to research any other types of identification needed for you to do business as an S-corp. Tax IDs will be required for all tax purposes and payments such as disability, social security, unemployment, payroll taxes, and income tax. You will use this Tax ID for anything related to federal tax and personal income tax.
Once 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.
How to Maintain Your S-Corporation
To keep the S-corporation 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, minutes/records must be kept of all the meetings. There also must be a record of the official company bylaws to make sure the shareholders and employees know what is expected.
S-corps require bookkeeping and accounting under GAAP (Generally Accepted Accounting Principles). Many business owners will hire an attorney to evaluate the S-corp frequently as there are many rules a corporation must follow.
A: Names must end with 'incorporated' or 'corporation.' You are typically allowed to submit an alternate name if your first name is ruled ineligible. Once approved, you may want to obtain trademark protection for your S-corp.
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 located in the state.
A: You do not need an attorney, but it may be helpful as they have experience with the incorporation process.
A: No, you may even be a sole shareholder. S-corps are limited to 100 shareholders per S-corp, but there is no limit or minimum for the number of shareholders.
A: You may incorporate it as an S-corp in all 50 states. Many choose their home state, but some choose other states such as Delaware and New York due to business-friendly laws.
How Can LLC Formations Help You?
There are many benefits that come with being an S-corp, such as liability protection and tax benefits. Obtaining S-corporation status takes a lot of work, but with the right help, you can have your corporation up and running in no time.
Contact the professionals at LLC Formations so we can help you register your S-corporation today.