If you're an entrepreneur who is interested in incorporating your business, there are a number of entity choices available to you. A popular choice is the S Corporation, which is a special type of corporation that offers similar taxation benefits to those of a partnership and an limited liability corporation (LLC).
Business owners who decide to form an LLC typically do so for its option of having "pass-through" taxation benefits. An LLC is usually not taxed as a single entity, and instead taxation "passes through" and is reported and paid by its individual owners, called "members."
An S Corp is taxed in a similar way. Having earned the Subchapter S designation from the Internal Revenue Service, an S Corp is treated as an entity separate from those who own it, meaning that the owners of an S Corp are sheltered from some – but not all – liabilities inherent in business ownership.
How can my business qualify as an S Corp?
A C Corporation is initially formed with Articles of Incorporation filed with the state of incorporation. To then change the status to S Corporation, the newly formed corporation files 2553 paperwork with the IRS, if it meets the following requirements:
- Be an eligible, domestic corporation – Ineligible corporations include insurance companies and U.S. businesses that sell to foreign buyers.
- Have a maximum of 100 shareholders - These shareholders may only include individuals, estates and certain trusts. Partnerships, non-resident shareholders and other corporations may not own shares of an S Corp
- Have one class of stock
Are there disadvantages to forming an S Corp?
"Pass-through" taxation allows business owners to avoid being taxed twice – once at the corporate level and then again at the personal level. However, to enjoy this benefit, owners of an S Corp must adhere to a rigid operational structure, says the U.S. Small Business Administration.
S Corps must keep thorough records of shareholder meetings and any key business changes. In addition, there are complex regulations involving shareholder distribution that, if not properly managed, could result in the company unintentionally paying higher employment taxes.