Previously in this blog series, we discussed sole proprietorships, partnerships, LLCs, and Corporations, and areas to consider when deciding on a business structure (read our first post in this series for more detail regarding these areas). In this post we'll be discussing S corporations.
A Subchapter S (S Corporation or S Corp.) is a form of corporation that meets specific Internal Revenue Code 1361 requirements, giving a corporation with 100 shareholders or less the benefit of incorporation while being a pass-through entity. S corporations pass income directly to shareholders and avoid double taxation on the dividends of corporations, while still enjoying the advantages of the corporate structure.
S corporations, like C Corporations, can be more complex than other business structures. They tend to have more costly administrative fees and complex tax and legal requirements. However, shareholders benefit from having limited liability and avoid double taxation that applies to regular corporations. Shareholders are limited to individuals, specific trusts, and estates, whereas shareholders of C Corporations may include other types of entities.
There are different tax and legal advantages and disadvantages for each company type. The following areas help break down the different tax and legal differences between entity types.
As mentioned in our most recent post, corporations take more effort than other entity types to form and are considered costly and time-consuming ventures to start and operate. Filing as an S corporation, requires that you register as a corporation first. Below illustrates the steps involved in setting up a corporation.
To file as an S corp., shareholders must sign and file Form 2553 (see Form 2553 Instructions) with the Internal Revenue Service within 75 days of starting a business. The following requirements must be met for a company to qualify for S corporation Status.
It's important to note that the ability to file as an S corp. is also possible for some limited liability companies (LLCs).
With regards to tax, S corps resemble a hybrid of corporations and partnerships. Where corporations are taxed first at the corporate level and then again at the shareholder level, S corps resemble partnerships, their income, loss, credits, and deductions are passed through to the shareholders. This enables S corps to avoid double taxation which C corporations are subject to.
Like corporations, subchapter S's are required to maintain a balance sheet and income statement and record corporate minutes annually. S corps must file annual corporate tax returns that the federal, state, and possible local level even though no tax may be due with these returns.
Click here for more tax and documentation information on S corporations.
Control falls to the owners, shareholders (up to 100), or in some cases the board of directors. These entity types are privately owned so the owners/shareholders make all the decisions, although they may choose to elect a board of directors to aid in the direction of the company. Unlike sole proprietorships where there is always only one owner, control is split between multiple individuals requiring a more intensive processes for decision making. The bigger the company and the more shareholders, the less control an individual has over the company.
With the ability to sell stock, corporations have an easier time raising capital than other structures.
Shareholders personal assets are protected from the risk of business debts and lawsuits. Only through their investment in stock of the company are shareholders generally held accountable.