If you’re a business owner or you’re thinking of starting a business, the type of business entity that you choose has a big impact on what you do. Choosing a legal entity for your business can impact everything from who can own the business to how you pay taxes. The success of your business can ride on choosing the right structure. Make the right choice, and you can maximize your profits and grow your company.
Whether your business is large or small, the type of structure you choose matters. There’s no right answer based on size, either. Even small businesses have a number of structure options that might be right for them based on the circumstances.
One of the types of business entities that you might choose is an S corporation. An S corporation is a type of corporation that has some special tax considerations that may be beneficial in some circumstances. But what is an S corporation?
What is a S corporation?
An S corporation is a type of business entity. An S corporation is a unique business structure that operates a lot like other corporations only with some special tax advantages. The most distinguishing trait of an S corporation is that profits pass directly to owners before taxes. Owners might choose to have an S corporation in order to enjoy the corporate structure of a traditional corporation along with the tax benefits that come with S-corporation status.
S corporations have been law since 1958. They’re legally considered a corporation with federal income tax that’s a lot like a partnership. There’s only one class of stock in a S corporation. All outstanding shares of stock have equal ownership interests and rights, and shares of stock may be voting or non-voting shares. Profits and losses are distributed in proportion to shares.
Is a S corporation a corporation?
Yes, an S corporation is a corporation. It’s just a special subtype of a corporation that gets some special considerations. An S corporation comes with all of the corporate structure that you expect from a corporation like articles of incorporation. Not all corporations are S corporations, but all S corporations are corporations.
How do I start a S corporation?
To start an S corporation, you must file paperwork with the Corporations Division of the North Carolina Department of the Secretary of State. You must pay the state filing fee and file Form 2553 with the Internal Revenue Service. All corporations need Articles of Incorporation that explain how the company is going to be structured.
What makes a S corporation unique?
An S corporation gives you the benefits of a corporation in terms of corporate structure, but it gives you the benefits of a limited liability partnership or a partnership when it comes to taxes. Unlike other corporations, an S corporation doesn’t have double taxation. That is, the corporation itself doesn’t pay taxes. Instead, the owners of an S corporation pay taxes on the profits the business makes.
An S corporation is beneficial in that owners can take advantage of the things that help corporations succeed while they also maximize profits to owners by avoiding the double taxation that happens with traditional corporations. Shareholders must report income on their individualized tax returns through a Schedule K-1. The income is taxed at each shareholder’s personal tax rate.
You might be thinking that S corporations sound great and that everyone should incorporate as an S corporation in order to save on taxes. It’s not always that easy. In order to incorporate as an S corporation, the business must qualify.
An S corporation is governed by the laws of the state where it’s organized. Generally, an S corporation may have only a limited number of shareholders. The number can be quite high, with as many as 100 shareholders allowed in an S corporation. No non-resident aliens may be shareholders, and other corporations and partnerships are ineligible to be shareholders.
An s corporation may own a subsidiary s corporation. Trust and estates may also own shares of a S corporation. Non-profit organizations organized under IRS code 501(C)(3) qualify to own shares in a S corporation. Spouses are treated as a single shareholder.
What are the benefits of a S corporation?
The primary benefit of an S corporation is that unlike general corporations, business profit isn’t taxed before it’s passed onto shareholders. In that respect, an S corporation is a lot like a partnership. However, S corporations also have the added benefit of a corporate structure.
Corporate structure allows the corporation to continue to operate without much interruption when owners come and go. In addition, articles of incorporation provide structure or how the business operates. A S corporation continues in perpetuity until the corporation’s representatives actively take steps to end it.
Where do laws for S corporations come from?
Laws for S corporations come from both state and federal law. IRS laws determine how an S corporation pays federal income taxes or how they’re exempt from income taxes. Federal law also decides what form you have to file and in what time frame to file in order to have special status. Federal S corporation regulations come from Internal Revenue Code sections 1361-1379. The state the corporation is in also makes the laws for how to file the corporate entity and how to comply with periodic reporting requirements.
A S corporation shareholder must pay themselves a reasonable salary
At first glance, it might seem like the best plan to keep taxes low is to avoid paying salaries to any shareholders who work for the S corporation. North Carolina law requires the corporation to pay the shareholders who work for the company a salary that’s reasonable. States and the IRS may even put extra scrutiny on S corporations in order to ensure that they don’t try to skirt employee taxation laws by avoiding salary payments to working shareholders.
Should I file as a S corporation?
A S corporation may be the right legal entity whether your business is large or small. It’s not the right entity in all situations, but the tax benefits can be lucrative if you qualify to operate as an S corporation. If you’re considering choosing the S corporation status, other business entities that are worth considering may be a general corporation or “C corporation,” a limited liability company and a partnership.
Because the business structure that you choose may ultimately have a big impact on your profits, your business operations and what you must do to operate lawfully, it’s important to weigh your options carefully when you begin a business venture. Wilson Ratledge can help you explore your options and decide which business entity is right for you.