Should Your Small Business Become an S-Corp?
Some businesses qualify for a unique tax status known as "S corporation" status, which exempts them from paying corporate income taxes.
If your company qualifies, adopting "S-corporation" status might result in significant tax savings. When people say "corporation," they typically refer to the most prevalent and well-known type: a "C-corp," which pays corporate income tax and has an unlimited number of stockholders. However, the designation "S-corp" has a different meaning. Our tutorial explains what S-corporations are and how they differ from other company formats.
What is the definition of a corporation?
A corporation is a legal body formed by submitting incorporation paperwork to your state. Corporations differ from sole proprietorships, partnerships, and limited liability companies (LLCs). Shareholders, directors, and executives make up a corporation. The shareholders own the company's stock, the officers handle the day-to-day operations, and the directors formulate rules and manage the "big picture." One individual can play numerous responsibilities in a small firm.
A corporation is different from its shareholders as a legal entity, which means that stockholders are not personally liable for the business's debts (shareholder liability is limited to the shareholder’s investment). Corporations must also comply with any legal requirements that do not apply to other enterprises, and holding frequent meetings is one of them.
What is an S corporation?
An S corporation is an established company that allows you to benefit from the restricted responsibility of a corporate shareholder while still paying income taxes as a sole proprietor or partner.
The firm itself is taxed on its earnings as a standard corporation (sometimes known as a C corporation). The owners only pay personal income tax on the money they get from the business in salary, bonuses, or dividends. On the other hand, in an S corporation, all earnings "flow-through" to the owners, who declare them on their tax returns (as in sole proprietorships, partnerships, and LLCs). The S corporation does not pay income tax, but a co-owned S corporation is required to file an informative tax return, similar to a partnership or a corporation.
Most states follow the federal model of not imposing a corporate tax and instead taxing the earnings on the shareholders' tax returns for S corporations. However, an S corporation is taxed similarly to a conventional corporation in around a half-dozen states. Your state's treasury department's tax division can inform you how S corporations are taxed in your state.
What Types of Businesses Qualify for S Corporation Status?
To qualify for S-corporation status, you must fulfill specific IRS requirements. Your company must:
Assume the role of a domestic firm. Your company must be based in the United States and operate there.
Only enable certain stockholders to participate. Individuals, trusts, and estates can all be stockholders in an S corporation, but they can't be partnerships or companies, or stockholders who aren't citizens of the United States.
Have a maximum of 100 stockholders. At no time during the company's life may the number of stockholders surpass this maximum.
There should only be one type of stock. Employees and investors cannot be offered various stock forms, such as regular stock and preferred stock.
The S corporation must be a qualified business type. Certain enterprises, such as financial institutions, insurance companies, and sales firms, are prohibited.
How do you go about becoming one?
If you determine that an S corp is the best option for you and your small business, consider a few things. First and foremost, remember in the case of your business specifically, that an S corp must abide by the following restrictions:
There shouldn't be more than 100 stockholders.
The company must be based in the United States, and the S corporation's stockholders must be citizens or legal residents of the United States.
The S corporation can only have one type of stock.
In the case of an IRS audit, like with any formal institution, it's critical to preserve meticulous records. However, with an S corp, adequate paperwork may save you a lot of money on legal fees. The sole difference between an S corp and any other type of business when it comes to forming one is the tax treatment.
How Do I Form an S Corporation?
You must first incorporate or organize your firm at the state level before you can pick an S corp classification. Every state is different, but regardless of where you reside, here is the knowledge you'll need.
Choose a name for your S-Corporation.
Corporation (Corp.), Incorporated (Inc.), LLC, and other corporate identifiers are required in the names of most LLCs and corporations. The types of IDs that are permitted differ per state. Some companies pick a DBA (Doing Business As) name to use as a trade name. This alerts the public if the trade name is different from the legal name.
When picking a name, double-check to see whether it's already taken. You may check if a name is available on the Secretary of State's website in most states. If the name you want is already taken, the state may reject your application. If you've decided on a name for your company but aren't ready to register it with your state yet, consider reserving it so it will be accessible later. Because having an online presence is essential, you should also get your website a domain name.
Selecting a Registered Agent
To receive legal notices and correspondence from the state office supervising business formation, corporations and limited liability companies (LLCs) must have a registered agent, also known as an agent for service of process. The registered agent must be available at a physical location in the filing state that is open during regular business hours throughout the year.
Place the formation paperwork in a safe place.
You must submit Articles of Incorporation, Articles of Formation, or whatever form your state requires in order for your firm to be legally recognized. For further information, contact your state agency. In most cases, the following information is required:
A company name
Name and address of a registered agent
An address for the company
Members' names, addresses, and signatures (LLC) or board of directors (corporation)
Remember that your formation paperwork isn't formally recognized as an S corporation for tax reasons until it is authorized. The IRS requires that you fill out a form.
Create bylaws for your company or an operating agreement.
The regulations that govern the running of your firm are corporate bylaws and operating agreements (LLC). Even if the state does not mandate it, all corporations and LLCs should have bylaws or an operating agreement to maintain effective governance.
File the necessary permits and licenses for your business.
Once your business structure is in place, you must get federal, local, and state permissions and licenses. In certain states and municipalities, conducting business necessitates obtaining a general business license.
Given all of this, determining what licenses and permissions you need to operate lawfully may be challenging, mainly because there is no one-stop shop to check for all of them.
Obtain an Employer Identification Number (EIN) from the Internal Revenue Service.
It's now time to obtain your Employer Identification Number (EIN), which the IRS uses to identify your business.
For operations like creating a corporate bank account, paying income taxes, and recruiting employees, you'll need an EIN. To keep everything separate from the owners, they should be conducted under the auspices of your corporation.
What are the benefits of being a member?
"S corporations" offer significant tax advantages and are especially handy if you need to sell or close your firm. Check to see whether any of these S corp benefits fit your business plan and long-term objectives:
Taxation on a pass-through basis.
S corporations are exempt from paying corporate taxes. Shareholders receive a portion of the company's earnings or losses, which they disclose on their personal tax returns. S corporations can avoid double taxation as a result of this. However, if your personal tax rate is higher than the business tax rate, this tax gain may become a liability.
Reduced tax on self-employment.
The taxable business income is split into two parts: distribution and pay. You may be both an owner and an employee in an S-corp, which implies you can earn a wage.
Only the salary component of your earnings will be subject to self-employment taxes, such as Social Security and Medicare. All of this enables you to exert some influence over your tax obligations. The smaller the salary, the lesser the amount of taxes that must be paid. To keep your S corporation status, you must pay yourself a "reasonable wage," which, if you do not, the IRS may interpret as an attempt to avoid paying taxes and terminate your eligibility.
Personal liability insurance.
S corporations safeguard owners' personal assets. Your personal assets cannot be confiscated as payment since you are not personally liable for the company's debts and liabilities. It's worth noting that many, but not all, states recognize the legal protections that S corporations provide. Check the laws in your state.
If you need to leave the firm, having an S corp status might make the process easier and faster. S corporations have their lifespan and are not reliant on the owner's life or engagement. It will be easier to sell, transfer, or develop your business due to this.
With all the information you need about an "S corp," you can now decide if you want your business to become an S corp. If you choose to pursue S corp status, Profit Bank will be here to assist you with all your business needs. We offer free bank accounts with built-in accounting software that will do the bookkeeping for your business. Business and banking shouldn't be a problem, and Profit Bank is here to help.
Whether your small business is sole proprietorship, partnership, limited liability, or a corporation we offer free banking and bookkeeping to all our members. We help speed up the accounting process, align your financial data with your bank statement, and automatically match transactions for reconciliation. All the relevant information is in one place and immediately synchronized. We do all the bookkeeping for your business without an additional charge.
With our free banking and bookkeeping services, we can ensure that your books are up to date, synchronized, and accurate.