The term S Corporation means Small Business Corporation. To qualify for an S corporation status, the company must meet the following requirements:
• It must be domestic (operate within the United States only)
• Have only allowable shareholders. Only individuals, certain trusts, and estates can qualify as allowable shareholders. Partnerships, corporations, or non-resident alien shareholders are not allowed in S Corporation.
• Have no more than 100 shareholders
• Requires that each shareholder has a US Social Security Number
• Requires that each shareholder consents in writing to the S Corporation election
• Requires that each shareholder is a United States citizen or a legal permanent resident.
• Have only one class of stock with all outstanding shares conferring identical rights to distribution and liquidation proceeds.
• Not be an ineligible corporation (which include certain financial institutions, insurance companies, and domestic international sales corporations).
• Must have a tax year ending on December 31.
S CORPORATION ADVANTAGES
- Tax Advantages
S Corporations are exempt from federal income tax except for certain capital gains and passive income. S corporations also have lower income tax and self-employment tax rates.
- Asset Protection
If you registered your business as an S Corporation, your personal assets are separated from the assets of your business, so if your business fails your personal assets will not be affected. The shareholders in an S Corporation are also protected from any liabilities for the company’s debts or liabilities. If your S Corporation fails creditors won’t be able to pursue the shareholders’ personal assets in the attempt to recover business debts.
- Flexible Characterization of Income
If you are an owner of S Corporation you have a certain flexibility in how to characterize your income for taxation purposes. This means you can be the owner/shareholder of your company AND a salaried employee at the same time. You can also pay yourself dividends from your S Corporation, that typically are either tax-free or taxed at a lower rate than the employee’s salary. Doing so allows you to reduce your self-employment tax liability. However, make sure you characterize your salary and dividends in a rational way, you don’t want to alarm the IRS by posting an artificially low salary to avoid paying self-employment taxes on the “dividend/distribution” portion of your income.
- Easy Transfer of Ownership
If you have an S Corporation ownership is easy to transfer to other owners without paying significant taxes or terminating the corporate entity. For an S Corporation to be transferred to another owner a standard transfer of business ownership agreement and a Schedule K-1 tax form reflecting capital gains and losses are all you need.
S CORPORATION DISADVANTAGES
- Just like with forming a C Corporation be prepared to having to file a lot of paperwork, including the Articles of Incorporation.
- An S corporation must adopt a calendar year as its tax year unless it can establish a business purpose for having a fiscal year.
- An S Corporation has limitations on the number of shareholders and can only have one class of stock. An S Corporation cannot exceed 100 shareholders.
S CORPORATION COMPLIANCE REQUIREMENTS
To qualify for an S Corporation status, a company must fill out and file with the Internal Revenue Service an IRS form 2553 no more than 75 days from the date of incorporation if the election is to come into force during the corporation’s first tax year.
After receiving form 2553, the IRS service center will notify the corporation within 60 days after receipt of the filing, whether the S corporation status has been approved.
If you miss the deadline for filing for the S Corporation status, you will have to wait until the next year to submit your request with the IRS again. If a corporation fails to submit its IRS 2663 form on time, the S Corporation election will not come into effect for that year, which means the company for that year will be taxed as a C Corporation.
