What is an S Corporation (S Corp)?

What is an S Corp? Structure, Requirements, and Benefits

All That You Need to Know About an S Corp

Businesses that meet the requirements may receive significant tax advantages by choosing “S-corp” status. A “C-corp,” which is a type of business that pays corporate income tax and can have an unlimited number of stockholders, is what most people mean when they casually refer to a corporation. However, the “S-corp” label has a different meaning.
In our guide, we define S-corps and explain how they differ from other business entities.

What is an S Corporation (S Corp)?

A business form known as an S corporation is one that is allowed by the tax code to distribute its taxable income, credits, deductions, and losses to its shareholders directly.
Because of this, it has some advantages over the more typical C corp. The S corp, an alternative to the limited liability company, is only available to small firms with 100 or fewer stockholders (LLC).
The Internal Revenue Code’s Subchapter S, which they have chosen to be taxed under, gives S corporations its name.
The main feature of a corporation registered under Subchapter S is: It qualifies as a pass-through organization because it can transfer business profits, losses, credits, and deductions straight to shareholders without paying any federal corporate tax.
As a result, it receives some unique tax advantages under the Tax Cuts and Jobs Act of 2017. However, it is responsible for paying taxes at the corporation level on certain built-in gains and passive income.

Requirements for an S Corp by the IRS

A company must satisfy specific Internal Revenue Service (IRS) requirements to be eligible for S corporation status.
It must only have one class of stock, be domestically formed (inside the United States), and have no more than 100 stockholders. Additionally, such shareholders must be eligible, which implies they must be either natural persons, particular trusts and estates, or specified tax-exempt organizations.
Corporations, partnerships, and nonresident aliens are not permitted to be eligible shareholders.

Setting Up an S Corporation

A company must first be incorporated before forming an S corporation. After that, it must submit Form 2553 to the IRS.
The IRS will only accept the S corp status if the company satisfies all requirements for the status. As stated, “all shareholders have signed the consent statement, an officer has signed below, and the exact name and address of the corporation (entity) and other required form information have been provided,” according to the document, which is known officially as Election by a Small Business Corporation.

Perks of S Corporations

The benefits of forming an S Corp include:
  • Tax Benefit: The main benefit is the absence of entity-level federal taxation, which is a tax benefit. Saving money on corporation taxes is advantageous, particularly in the early stages of a business.
  • Lower Personal Income Tax: S corp status might also help business owners pay less in personal income taxes. S corp owners frequently reduce their self-employment tax obligation by classifying money they receive from the company as a salary or dividend. Deductions for business expenses and employee wages are made possible by the S corp status. S corp shareholders can benefit from tax advantages for pass-through corporations as well.
  • Self Employment: If the distribution does not exceed their stock basis, shareholders of S corporations are permitted to work for the company, earn wages, and receive tax-free corporate dividends. Dividends that are in excess of a shareholder’s stock basis are taxed as capital gains. Nevertheless, these profits are taxed at a lesser rate than regular income.
  • Easy Transfers: Other benefits include the freedom to transfer interests or change the basis of real estate. You can do this without worrying about negative tax effects or having to follow intricate accounting regulations.
  • Greater Credibility: By demonstrating the owner’s official commitment to the business, the S corporation status may assist establish credibility with potential clients, workers, suppliers, and investors.

Potential Drawbacks of Registering as an S Corp

The disadvantages of filing as an S corporation are as follows:

  • IRS Scrutiny: The IRS carefully examines how S corporations pay their employees because they can pass off salaries as corporate distributions to avoid paying payroll taxes. Before making any distributions, an S corporation must pay shareholder-employees reasonable remuneration for the work they have completed.
  • Strict Distribution: The S corp shall distribute profits and losses to stakeholders in accordance solely with the proportion of ownership or number of shares that each shareholder owns.
  • Subchapter Status: If an S corp fails to apportion earnings and losses correctly or engages in any other noncompliance actions, such as errors in an election, consent, notification, stock ownership, or filing requirement, the IRS may in rare cases terminate the S corp’s Subchapter S classification. However, non-compliance errors that are quickly corrected can typically prevent any negative effects.
  • Time and Money: Setting up an S corp is a time- and money-consuming process. Articles of incorporation must be filed with the Secretary of State in the state where the business is located. The corporation must pay other expenses related to its incorporation, as well as find a registered agent for the company.

Comparing S Corp and C Corps

S corps and C corps are comparable in the following ways:
  • Both are financed by issuing shares of stock.
  • Both call for the selection of corporate leaders, such as a board of directors.
  • Boards and shareholders are both required to hold frequent meetings and retain full records of such meetings.
  • Both are responsible for creating, submitting, and upholding the company’s bylaws.
  • Shareholders are both protected from corporate liability.
  • Shareholders of C corporations and S corporations both pay personal rates of tax on company distributions.
They are also non-comparable in a few significant ways:
  • S corporations are allowed to issue shares to a maximum of 100 shareholders, all of whom must be natural persons (as opposed to corporations) who are either US citizens or lawful permanent residents. C corporations are not subject to any limitations on the number or kind of shareholders.
  • S corporations may only issue one kind of stock. Common and/or preferred stock may be issued by C corporations.
  • S corporations only pay taxes on employee wages. On distributions and salary, S corp owners must pay personal taxes. All of the aforementioned are taxed by C companies in addition to corporate revenue.

Exploring the Similarities and Differences Between S Corp and LLCs

The IRS recognizes S corporations as a distinct category. LLCs are taxed in the same way as a sole proprietorship or partnership by default, contrary to popular belief. But LLCs have the option to choose S corporation taxation.
There are several similarities between LLCs and S corporations:
  • Owners of both are largely subject to personal income tax and employment taxes, which are under their purview.
  • Both are able to transfer gains and losses to ownership.
  • Owners or shareholders are both protected from corporate responsibility.
There are also a number of striking differences:
  • Taxes on self-employment are normally paid by LLC owners on all business income. S corporations enable owners to distinguish their wages from distributions, which are subject to employment tax (which are not).
  • Up to 100 shareholders may get shares from S corporations. LLCs do not issue shares. Instead, they are owned by “members,” and they are permitted to have an infinite number of members.
  • S corporations can only be owned by people who are permanent residents or US citizens. The LLC is not governed in this way as a business entity.

Why Should You Register as an S Corporation ( S Corp)?

S companies, which combine the advantages of corporations with the tax advantages of partnerships, might be the best of both worlds for a small firm.
S corporations specifically provide the corporate structure’s limited liability protection, which prevents access to an owner’s personal assets by business creditors or litigants making claims against the firm. They do not, however, pay corporate taxes on any earnings or income they produce, unlike partnerships. In the event that the owners’ pay is set up as a salary or stock dividend, they may also assist in avoiding self-employment tax.
S companies are a popular legal structure that is suggested for small businesses.
They offer limited liability protections for companies along with the tax benefits of partnerships. They are less complicated to set up and keep in operation than standard C corporations, serving as a sort of “corporate lite” form.
S corporations must follow many of the rules and pay many of the fees associated with traditional corporations, beginning with the fees and formalities for incorporation. They require more time and money to set up and manage than LLCs, another common small-business structure.
Although helpful for rapidly expanding businesses, they are nevertheless subject to specific IRS limits on their size and stockholders, which may ultimately restrain their growth. The good news is that, should business circumstances let it, an S corp can convert to C corp status rather easily.