A corporation is an independent and legal entity, separate from its stakeholders or owners. It requires complying with more tax requirements and regulations. There are two types of corporations;
- C Corporation
- S Corporation
What Is an S Corporation?The S Corp is a type of business entity that provides significant tax advantages while preserving ownership flexibility. It is also known as a small business corporation or subchapter. S Corp is a tax code that was enacted into law in 1958. The main purpose of S Corp is to support and encourage the idea of small businesses while cutting down the double taxation scheme.
Why Do You Need to Form an S Corporation?When a business starts to grow and succeed in a well-established company, the tax rate tends to increase. Moreover, growing companies also face a variety of complexities, especially during tax season. Therefore, forming S Corporations or S Corp is important.
How Is an S Corp Better from A C Corp Or An LLC?Unlike C Corporations (C Corps), the S Corporation does not involve corporate income taxes. Instead, it receives different treatment for taxation that is more favorable for the business owner. Moreover, similar to the LLC, S Corp is a pass-through entity for tax purposes. It means that the income earned or generated by an S Corporation will pass through to the shareholders’ income tax returns. In short, the S Corp itself does not owe any tax liability. In addition, structuring your business as an S Corp also provides you the flexibility to manage your company’s ownership. The stock of S Corporations is freely transferable, unlike LLCs. This gives S Corporations; they can sell their ownership interest without getting approval from other shareholders.
How S Corporation Help You in Reducing the Tax Burden?S Corporation can also help you save from paying additional taxes. One of the major concerns for business owners is to reduce their liability for self-employment taxes. The compensation of S Corporation shareholders is not subjected to profits but their self-employment tax. This can minimize the overall tax burden by reducing your business profits that are subject to self-employment taxes. In short, depending on how your income appears on your personal tax return and how you pay yourself throughout the year, you can effectively manage your tax burden. For this, you can also consult your professional tax advisor or accountant to find you the best way to structure your business earnings for tax purposes.
What Are the Limitations of S Corporation?Although S Corporation provides numerous tax advantages and ownership flexibility, it is still not suitable for every business type. There are a few limitations as well, which require to be followed.
- An S Corp must not have more than 100 shareholders. (https://www.incfile.com/what-is-s-corporation/)
- It must be a domestic business entity.
- All shareholders of the S Corporation must be legal residents of the United States.
- It is restricted to only one class of stock.
How Can You Get S Corporation Status?According to the IRS, a business should fulfill all of the following requirements to qualify for S Corporation status:
- It should be a domestic corporation.
- It should have only allowable shareholders, such as certain trusts, individuals, and estates.
- Shareholders must not include corporations, partnerships, or nonresidents.
- The company should not have more than 100 shareholders.
- It should only have one class of stock.
- The company should not be an ineligible corporation such as insurance companies, financial institutions, and domestic, international sales corporations.
- Finally, the corporation should also submit Form 2553 to have S Corporation status for tax purposes.