The S corporation is a popular business type, but it is also misunderstood and, some say, overused as a protection against liability. The s corporation has benefits and drawbacks, but overall it is useful for small businesses that want to protect owners from liability and enjoy the benefits of pass-through taxes.
The best way to look at an S corporation is that it's a hybrid. An S corporation is a corporation for legal and liability purposes, and a partnership for tax purposes. That is, the S corporation has liability protections for owners because it is, in fact, a corporation, and a separate entity from the owners. But the profits of the S corporation are distributed to, and taxed to, the owners in the same way as the partners in a partnership.
An S corporation is a corporation that elects to be taxed through the shareholders' personal tax returns. Not every corporation can become an S corp; the IRS has imposed some restrictions on ownership of an S corp, and S corp status must be elected no later than a specific date each year. There are advantages and disadvantages to S corp status, as compared to self-employment and to LLC membership.
Only certain types of corporations are eligible to elect S corporation status. There are 8 requirements including limited number of shareholders, only U.S. citizens, and only certain types of entities.
Benefits of becoming an S corporation include lower taxes (income tax and self-employment tax), and the pass-through nature of S corp taxes allows owners to reduce their total tax bill or payes at a lower rate than the corporation would pay.
The disadvantages of S corp status are the same as those for other corporations: the complexity of requirements and paperwork needed to maintain this status. An LLC does require this same level of requirement. For example, a corporation must have an annual meeting but there is no such requirement for LLCs.
The S corp is a type of corporation but it is taxed differently from a corporation. A corporation pays income tax as a separate entity, while an S corp pay income tax through the tax returns of its owners, according to their percentage share of ownership.
S corporations and limited liability companies (LLCs) both have limited liability and both have pass-through taxes (taxes for the business are passed through to the owners/members. So how are S Corp and LLC structures and taxing different? These articles describe the differences in payment to owners/members, in taxes, and other key areas.
Starting an S corporation is just like starting a corporation. First you incorporate the business, then you file for an s corporation election.
A business becomes an S corporation in two steps:
- First, the business becomes a corporation by filing Articles of Incorporation with a state.
- Then, the corporation elects s corporation status.
The election must be made within a specific time after incorporation, but it can also be made any year, for the following year. Read more details about the S corporation election process in this article.
An S corporation files a tax return for the corporation on Form 1120-S, but the corporation's income and expenses, dividends, and other items are distributed to shareholders through Schedule K-1.
To file an S corp income tax return, you will need a profit & loss statement for the year, and balance sheets for the beginning and end of the year, as well as details on corporate officer compensation, cost of goods sold, asset records for depreciation calculations...see the list for more.