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S Corporation- Definition
S Corporation is a closely held corporation by the Internal Revenue Code of the United States federal income tax, wherein the corporation is not taxed but the income or losses are distributed to the shareholders. The individuals then report this income or losses in their personal returns and pay taxes individually. They are taxed at their personal income tax rates.
Features of S Corporation
- Limited liability of the members. This means one cannot use the personal assets of the shareholders for discharging the liability of the corporation.
- The corporation need not pay federal taxes at the corporate level. The income or losses are disbursed to the shareholders who will pay their personal income tax returns. Hence, the business losses can be set off against the income of any other shareholder. This might be really helpful for taxation purpose.
- Avoidance of double taxation.
- S Corp has a perpetual existence. It doesn’t affect by any owner’s death or dismissal.
How to Incorporate?
Step 1: Formation
Filing the appropriate formation documents and paying the filing fees with the state.
Step 2: Obtainment of EIN
Need to obtain EIN (Employer Identification Number) by filing form SS-4 with IRS (Internal Revenue Service). One can apply online, by mail, or through phone (for international applicants).
Step 3: Filing of Form 2553
Filing of Form 2553 with the IRS and listing out the following information:
- Company Name and Address,
- EIN Number,
- State and Date of incorporation,
- Shareholders or members information,
- The effective date of the election,
- Fiscal Tax year information.
Once one complies with the above-mentioned formalities, it will take approximately 60 days to receive an acceptance letter from IRS. After the receipt of the acceptance letter, one can officially operate as an S Corporation.
Qualification for S Corporation
- Has to be a Domestic Corporation.
- Not more than 100 shareholders.
- Shareholders allowed are individuals, certain estates and trusts. Not allowed shareholders are non-resident aliens, partnerships and corporations.
- Only one class of stock.
- Ineligible Corporations not allowed.
- Shareholders need to of U.S citizens or residents only. Also, they need to be natural persons only.
Advantages of S Corporation
- There is a limited liability of the managers and the shareholders unless otherwise stated to any. Their assets remain protected. Creditors cannot claim on the shareholder’s house, property, or bank accounts for their payments.
- Favorable tax characterization.
- The shareholders can draw a salary as employees. They can also receive dividends and distributions that are tax-free to some extent in their investments. The owner-operator relationship will reduce the burden of tax liability. This helps in incurring more business expenditure like wages payment which can be a business expenditure allowable as deduction.
- One can transfer the easily by the sale of stock. The corporation need not make any entries or comply with any accounting regulations for transferring the ownership.
- Since the individuals are taxed at their personal tax returns, their tax rates might be lower as compared to that of corporates.
- Shareholders are not subject to self-employment taxes.
- This business structure gets more credibility than a sole proprietorship or a general partnership.
- Generally, there is a less risk of audit.
Disadvantages of S Corporation
- Payment of incorporation fees can be a slight expensive.
- It has to be a U.S. corporation only. Hence, this a major con.
- One has to qualify as per the requirements. Such requirements are not there in C Corporation.
- Comparatively more difficult to set up, in case of filings, record keeping, board meetings etc.
- S Corporation may lose its status if there is no proper recordation and filing of the same in time.1