A corporation is a legal entity owned by shareholders, the authorized capital of which consists of shares. Each ordinary share gives the same rights to its holder in matters of management and receipt of dividends. The existence of the Corporation begins from the moment of its registration with the Secretary of State. Shareholders are liable for the affairs of the Corporation only to the extent of the value of their shares. However, the Corporation is not liable for the personal debts of shareholders.
There are two types of corporations, S-Corporation and C-Corporation. Today, we are going to review the first type of corporation.
What is an S Corporation? To begin with, an S Corporation or an S Corp is not a formal business structure. It is a tax classification. Both an LLC and a Corporation can choose to be taxed as an S Corp.
S Corporation Status Eligibility
A business can elect to be taxed as an S Corporation in accordance with section 1362. It can maintain this status as long as it meets the following criteria:
- The number of its shareholders does not exceed 100.
- All of its shareholders are individuals (exceptions apply to various organizations, inheritance funds, and tax-exempt trusts).
- It does not have shareholders who are non-residents temporarily residing in the country.
- Its shares are only one class of stock.
As was mentioned earlier, the LLC and Corporation meet the criteria for being an S-type corporation taxable entity.
Who Should and Should Not Consider an S Corporation?
Partnerships, investor groups, or even existing corporate shareholders looking for the dual benefits of limited liability and pass-through taxation should seriously consider S Corporation status so long as the eligibility rules can be met and upheld.
What is an S Corporation’s advantage over LLC? Unlike LLC, the S Corporation members are paid salary, which is subject to income and employment taxes, as well as distribution, which is subject only to income tax. Thus, the main benefit of the S Corporation is that it saves you from paying self-employment tax on distributions.
It is also the best choice if your business makes a lot of money that you want to take out of the business in the same year. If you want to reinvest, though, an LLC or C Corp might be a better option. Another small benefit of being an S Corp is that it enjoys a lower audit rate. However, lately, the IRS has been checking more thoroughly if the “reasonable salary” is truly reasonable and not too low, in which case the S Corp status can be taken away.
Although an S Corporation allows to potentially save in a couple of different ways, maintaining S Corp eligibility and complying with all the requirements takes more effort. What is an S Corporation status going to cost your company? The cost includes running payroll to pay the salary, taking care of more complicated tax withholdings, and so on.
This increased complexity of having an S Corporation status is going to require the cost and work of a professional accountant. So, if you are just starting as a business, becoming an S Corp is not the best decision. After all, you may have very low or no profits at all for some time and the added-on costs will outweigh the benefits.
Finally, if you are participating in passive income activities, such as rental real estate, then you should consider another form of taxation for your business. Otherwise, you will be paying self-employment taxes on an income that you would otherwise not be paying this tax.