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S Corporation ? What Is It?

For many small businesses, the "S" corporation is the business entity of choice. The "S" in S corporation refers to a tax designation. All corporations are created the same way under state law. A small business must then chose a tax status, to wit, "C", "S" or non-profit. Important issues concerning S corporations are covered in this article.

C Corporation v. S Corporation

Federal tax laws automatically consider every corporation to be a "C" designation. A small business, however, may elect to be designated as an "S" corporation by filing IRS form 2553. The election must be made prior to the tax year in which it is going to be effective. All shareholders must sign the election.

A C corporation stands alone for tax purposes. It must file tax returns and pay taxes on profits. Profits and losses are reported on the corporate tax return and do not pass through to shareholders. C corporations can elect any calendar month as the end of their fiscal year.

An S corporation is a pass through entity for tax purposes. It does not file a tax return for the purpose of paying taxes, but does file information returns. All profits and losses are passed through to the shareholders. In turn, each shareholder reports the profit or loss on his or her individual tax returns in proportion to their ownership interest. For instance, if you own 30% of the total issued shares, 30% of the profits or losses must be reported on your personal tax returns. S corporations must have a fiscal year-end of December 31. If you intend to eventually take your business public, you cannot use an S corporation.

Although S corporations are a tax choice, there are limitations on what corporate entities can make the election. The biggest hurdles are:

1. There can be no more than 75 shareholders;

2. Each shareholder must be a person, not a business entity; and

3. There can be only one class of stock.

Benefits

While S corporations provide relief from the tax filings of a C corporation, there are negative aspects to using them. Simply put, a C corporation can write off more expenses. S corporations may not be able to deduct certain types of insurance and costs of doing business. The list is fairly complicated, so you should speak with a tax professional prior to deciding which designation works for your business.

S Corporation vs. Limited Liability Company

S corporations have a definite tax advantage over limited liability companies ["LLC"]. Distributions from LLCs to shareholders are subject to self-employment tax [15.2 percent] in their entirety. Distributions from S corporations, however, can be broken down into two categories, salaries and dividends. The dividend distributions are not subject to the self-employment tax. Avoiding self-employment tax can make a substantial difference in the amount of money you take home.

In Closing

I always laugh when someone emphatically says that every business should be formed as a particular entity. Such statements are simply wrong. The "best" business entity depends entirely on the nature of your business. In many instances, S corporations are ideal.

Richard Chapo, Esq., is a business lawyer with http://www.sandiegobusinesslawfirm.com - offering legal advice to San Diego businesses. This article is for general education purposes and does not address every facet of the subject matter. Nothing in this article creates an attorney-client relationship.

In The News:

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Reema Iqbal is talking to us from behind the plastic sheeting which marks the tented area which is now her home in Roj camp in northeast Syria.

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Hundreds of civilians still living in Islamic State's final enclave have emerged and are being used as human shields - forcing US-backed troops to delay capturing the village.

Nigeria postpones presidential election at last minute
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The funeral of Emiliano Sala is set to take place in Argentina following his death in a plane crash over the English Channel.

India vows 'crushing response' to Kashmir bombing
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India's prime minister has warned Pakistan of a "crushing response" to a suicide bombing that left at least 41 soldiers dead in Kashmir.



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