What is an S Corporation, and How Can It Benefit Entrepreneurs?
According to the S Corp Organization, estimates from the IRS show that there are 5 million S Corporations in the U.S. – three times more than C Corporations. Introduced in 1946, S Corp rules have since changed significantly, lending them more flexibility.
One of the main advantages of an S Corp is that any business owner – LLC or sole proprietor – can opt to turn their business into an S Corp and benefit from its benefits.
What is an S Corporation?
Named after the Subchapter S of the Internal Revenue Code, an S corporation can pass profits, losses, deductions, and credits onto the individual tax returns of the owner or shareholders, avoiding paying corporate tax and double taxation.
An S Corp is not a type of business structure but a tax classification and business owners get a salary and distributions to help reduce the tax burden. The salary must meet the market rate based on the individual’s qualifications to ensure owners don’t pay excessively low self-employment tax rates. The business owners pay both income and employment taxes on their salary but not on their net profits.
Businesses must meet specific qualifications before becoming an S corp. These include a location within the United States, and they may only issue one class of stock. Furthermore, the business can only have up to 100 shareholders, individuals, trusts, estates, or a non-profit. Finally, partnerships and no alien residents cannot own an S Corp.
How Can Entrepreneurs Benefit From an S Corporation
Structuring a business as an S Corp offers entrepreneurs several benefits:
Limited Liability Protection
An S-corporation provides the owner and shareholders with limited liability protection. Their personal assets remain separate from the business assets, solid defense in case of a lawsuit or bankruptcy.
A corporation can exist into perpetuity as long as it remains compliant, even when one of its shareholders sells or passes away.
The tax savings offered by the pass-through taxation is the most significant benefit of an S Corp. Owners pay taxes on the profits and losses as income tax, depending on their tax bracket. However, considering that the owners need to pay income and employment taxes, the tax advantages might not be as beneficial with an S Corp. Advice from an accountant or attorney is advisable.
Transfer of Ownership Ease
In most states, S Corps facilitate a more effortless transfer of ownership when selling the business or buying out a shareholder.
Finally, S-corps and other incorporations create credibility because of the time, effort, and money required to register and maintain them. The more credibility a business has, the better it reflects on clients, creditors, vendors, and employees.
Forming An S Corp In California
Like everywhere else, an S Corp is not a business structure but an IRS classification for taxation in California. Therefore, any LLC or corporation can opt to start an S Corp in California. Businesses elect the S Corp status when applying for an EIN from the IRS by filling in Form 2552. However, Californian companies pay a 1.5% franchise fee when choosing to become an S Corp.
Starting An LLC With S Corp Status
TRUiC provides actionable guides and tools for startups and business owners. For example, their recommendation for forming an S Corp in California is to start an LLC and elect S Corp in five easy steps.
Step 1: Start with the naming of the LLC by following the Californian naming requirements.
Step 2: The next step is to choose a registered agent to receive communications on behalf of the business.
Step 3: Filing the Articles of Organization is the next step for officially registering the LLC.
Step 4: An Operating Agreement is a legal document outlining all aspects of the LLC, including members’ ownership and duties.
Step 5: Finally, while requesting an EIN from the IRS, the business owner also files Form 2553, electing the S Corp tax status.
The steps for seeking S Corp status in California are straightforward, and the only extra burden is the 1.5% franchise tax. However, before electing the tax status, it is always good to check if the business meets all the requirements and whether it remains the best structure for the company.
This article has been published in accordance with Socialnomics’ disclosure policy.