By: Heather Green Miller, Esq.
An S-Corporation (S-Corp), also known as an S subchapter, is a tax designation that a corporation can choose when setting up the entity's tax structure which meets specific Internal Revenue Code requirements.
What is the difference between an S-Corporation and a C- Corporation?
The difference between an S-Corp and a C-Corp is (1) how the corporation is taxed, (2) how the shareholders will be taxed, and (3) the requirements regarding the number of shareholders. For an S-Corp, you may have 100 shareholders or less and have the benefit of incorporation while being taxed as a partnership. The business may pass business income, losses, deductions, and credits to shareholders, which is referred to as “pass-through taxation”. This means that each shareholder reports income and losses on their individual tax returns, and pays taxes at ordinary tax rates.
For a C-Corp you must have over 100 shareholders and both the shareholders and the corporation are taxed, this is known as “double taxation”. The corporation is taxed on its earnings or profits, then the shareholders are taxed again on dividends they receive from those earnings. A C-Corp must comply with more federal and state requirements, unlike an S-Corp. Filing as a C-Corp is more attractive to investors and corporations that ultimately want to be a publicly held company where it will offer stocks to the public.
What are the benefits of an S-Corporation?
One of the biggest benefits of filing as an S-Corp is avoiding double taxation. The Corporation may pass business income, losses, deductions, and credits to shareholders instead of the Corporation while the shareholders are taxed separately. Saving money on corporate taxes is beneficial, especially to a newly established business. Shareholders can be employees, earn salaries, and receive corporate dividends that are tax-free, unlike a C-Corp. An S-corporation protects the personal assets of its shareholders by creating a separation between one’s personal and business assets, therefore limiting the shareholders' personal liability for debts of the corporation.
How does S-Corp taxation work?
Similar to a partnership, shareholders of an S-corporation are taxed on their allocated share of the business’s profits regardless of whether or not those profits were actually distributed to them. The shareholders’ are not taxed on distributions from the business, so long as those distributions do not exceed one’s contribution to the corporation. In other words, shareholders do not pay corporate taxes instead, individual shareholders split up the income or losses amongst each other and report it on their own personal tax returns.
How do you start an S-Corp?
First, you must create a business entity, one must choose to register as a Limited Liability Company (LLC) or a Corporation (INC) and register the business with their specific state. An LLC or INC can both elect to be an S-Corp designation. Generally, LLCs
choose the S-corp designation because of the limited number of shareholders. The corporation must meet the requirements of having no more than 100 shareholders, issuing one class of stock, and the shareholders must be individuals as opposed to being a partnership or an existing business. Once the corporation is formed and the required documents are filed with an individual's state, you file form 2553 with the Internal Revenue Service (IRS) and elect the S-Corp designation. When filing the form, you’ll need the signatures of all of your shareholders and meet the timeline restrictions. Within 60 days of filing, you will be notified that your application will be accepted. Once accepted, your S corporation tax status will remain in effect until it’s terminated or revoked.