What is an S Corporation?
An S corporation is a specific type of business entity. It is sometimes referred to as an “S-Corp” or an “S Subchapter.” The entity is usually associated with smaller businesses (typically those having less than 100 shareholders). The main feature of an S corporation is that it can pass income directly to shareholders without having to pay federal corporate taxes.
What are the Requirements for S Corp Status?
A business must meet certain IRS requirements to obtain an S corporation status. The main conditions include that the company must:
- Be incorporated within the U.S.,
- Have only one class of stock,
- Not have more than 100 shareholders, and
- Have shareholders who meet certain eligibility requirements.
The latter “eligibility requirements” are that shareholders must be:
- Specific trusts and estates, or
- Certain tax-exempt organizations.
Partnerships, corporations, and nonresident aliens cannot qualify as eligible shareholders.
What are the Key Features of an S Corporation?
Perhaps the main feature of an S subchapter is that it can pass business income (as well as losses, deductions, and credits) directly to shareholders, without paying any federal corporate tax.
Note that S corp shareholders report income, gains, and losses from the corporation on their individual tax returns. They then pay taxes at their ordinary income tax rates. Since the money comes to shareholders free of corporate tax, they avoid double taxation on any income or earnings.
But for its tax status, S corporations are similar to any other ordinary corporation. For example, they offer similar liability protection and typically must observe certain internal formalities (like have a board of directors and conduct shareholders’ meetings).
What are the Main Benefits?
There are two main benefits of an S corp. These are:
- The tax benefits (again, S corporations do not have to pay federal taxes at the business level), and
- S corporations can usually transfer interests without facing adverse tax consequences or having to comply with complex accounting rules.
What are the Main Cons?
The main disadvantage to an S corporation is that the IRS often scrutinizes how an S corp pays it employees. This is because these entities can disguise salaries as corporate distributions to avoid paying payroll taxes. Note that S corps have to pay reasonable salaries to shareholder-employees before making any distributions.
Contact The McWilliams Law Group for Help
When you are ready to open a new business or take your current business to the next level, the lawyers at The McWilliams Law Group are here to help. We can help ensure that your operations provide you with the tax and liability protections that best fit your short- and long-term plans. Our attorneys work closely with business owners throughout Washington and California, providing individualized and strategic advice to help their businesses run smoothly. Contact us now and get the skilled business advice that you deserve.
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