If you are a small business owner or you are planning to start a business, you may have some preliminary concerns to address at an early stage of the execution of your business plan. One of these preliminary questions is what type of legal entity may be best for you.
A consultation with an experienced Business Attorney will help you make an informed decision that is right for you. Your options depend on your short- and long-term business goals and on the type of business you are about to start. Do you need liability protection? Will you have business partners? Will you hire employees or raise capital in the future? Will your immigration status and income level have an impact on the type of entity you choose?
What Is An S Corporation?
An S Corporation is a special type of corporation that avoids the double taxation typical in C Corporations. S Corporations, like Limited Liability Companies (LLC) and Partnerships, are pass-through tax entities. This means that S Corporations allow that profits and losses to be passed through directly to the shareholders’ personal income.
Is An S Corporation Recommended?
This type of entity is recommended for small businesses; however, there are several other factors to consider.
What Are The Advantages Of An S Corporation?
One of the major advantages is that shareholders are not subject to double taxation on income. In fact, the income and loss are allocated pro rata to each shareholder according to their number of shares.
The S Corporation can also pay its shareholders a “reasonable salary” and it will only be taxed for Social Security and Medicare on the salary paid to the shareholders, and not on the pass-through income.
The S Corporation can only have one class of stock and no more than 100 shareholders, all of them must be U.S. residents. This means corporations and non-residents aliens cannot own shares of the S Corporation.
Shareholders have liability protection for their personal assets, provided that there is a complete separation between the corporation and the shareholders affairs.
A greater than 2 percent shareholder of the S Corporation can deduct 100% of the health care premiums paid by the corporation under a group health insurance. In those states where a group health insurance is not possible when the company only has one employee, still can deduct the health insurance premiums even if the plan is purchased in the name of the shareholder.
The S Corporation gives the ability to write off start-up losses. These can be offset against the shareholders personal income.
What Are The Disadvantages Of An S Corporation?
There is a maximum of 100 shareholders allowed in S Corporations and only one type of stock.
Only U.S. individuals, estates, and certain trusts can be shareholders.
The S Corporation is less attractive to outside investors. If you will need venture capital, a C corporation may be a better choice.
Shareholders must follow corporate formalities, have regular meetings and maintaining minutes.
To qualify for S corporation status, the corporation must meet the following requirements:
- Be a domestic corporation
- Have only allowable shareholders
- May be individuals, certain trusts, and estates and
- May not be partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
In order to become an S corporation, the corporation must submit Form 2553 Election by a Small Business Corporation signed by all the shareholders. See the Instructions for Form 2553 PDF for all required information and to determine where to file the form.
S Corporations can be the right choice for your business if you are looking for liability protection and pass-through taxation. However, you also need to consider the advantages and disadvantages of the S Corporation against your business needs and discuss your case with a trusted business attorney before making a decision.