What is an S-corp? Do you need one?
An S-Corp is a happy middle ground between an LLC and a C-Corp, as a tax designation for an LLC (it is not an official business entity type). With an S-Corp, the business acts as a pass-through tax entity. Because of this, the business does not pay federal income taxes as all profits and losses are passed through to the owners. The owners must then report those losses and gains on their personal tax returns, thus avoiding the double taxation of a Corporation.
In order to register as a S-Corp there are a few guidelines that need to be met. The business must have less than 100 owners/shareholders, all shareholders must be individuals (not corporations), you may only have one class of stock, and a U.S. resident must own the business.
Benefits of an S-Corp:
Limited liability: Similarly to an LLC, with an S-Corp tax designation, all owners or shareholders are given personal liability protections. The owner’s/shareholder’s personal assets cannot be seized for business liabilities. In a sole proprietorship, the business and the owner are one and the same, leaving their assets vulnerable.
Pass-through tax status: The S-Corp does not pay taxes, the owners pay their share of profits and losses on their personal tax returns.
Tax-favorable characterization of income: S-Corp shareholders can be employees of the business and draw salaries as employees. They can also receive dividends from the LLC, as well as other distributions that are tax-free to the extent of their investment in the LLC. A reasonable characterization of distributions as salary or dividends can help the owner-operator reduce self-employment tax liability, while still generating business-expense and wages-paid deductions for the corporation.
Elimination of double taxation: S-Corps are not taxed twice, while C-Corps are taxed at the corporate and individual level.
Once-a-year tax filing requirement: C-corps file estimated taxes quarterly, but S-corps file annually.
Straightforward transfer of ownership: Interests in an S-Corp can be freely transferred without triggering adverse tax consequences. The S-Corp does not need to make adjustments to property basis or comply with complicated accounting rules when an ownership interest is transferred.
If your business fits the requirements of an S-Corp, the tax benefits alone make it worthwhile to consider. While there are many benefits to filing as an S-Corp, there are other options you can consider as well. Evaluate all the options and see what will benefit your business the most!
