By Dean ‘Mac’ Nichols, Attorney
This is the first of a three-part series on different structures of business entities.
An S corporation, also known as a subchapter S corporation, is a pass-through tax entity. This means that income is passed through to shareholders in proportion to their investments and taxed at personal income tax rates. A corporate entity provides a strong measure of protection so the personal assets of the owners are not liable to creditors and/or lawsuits seeking financial compensation from the business entity.
S corporations are allowed up to 100 shareholders and one class of stock. This type of corporation is often attractive to small-business owners because it offers the tax benefits of a partnership and liability protection of a corporation. Because income and losses are passed through to shareholders, there is only one level of tax.
If an S corporation does not have inventory, the owner can also use the cash method of accounting rather than the accrual method. This means that income is taxable when it is received, and expenses are deductible when they are paid.
When deciding whether or not an S corporation is the best fit for your small business, it is also important to consider the downsides. As corporations, S corporations are subject to higher legal and tax service costs. The legal and accounting costs of setting up an S corporation are comparable to those of a standard (C) corporation. Also, shareholders may not be a corporation, a partnership, or certain types of trusts.
To establish an S corporation, the organizer is required to file articles of incorporation. The officers must keep corporate minutes, hold directors’ and shareholders’ meetings, and allow shareholders to vote on major corporate decisions.
Choosing whether to create an S corporation or an LLC confuses many small-business entrepreneurs. Both offer the benefits of pass-through taxation, which eliminates the possibility for double taxation. The advantage in choosing an S corporation is that the owner can bifurcate the profits from the business and reduce the overall tax obligations. Taking part of the profits as wages and the remainder as a distribution reduces social security/self employment taxes as well as the new 38% NII tax and the .9% Medicare tax.
Does an S corporation sound right for your business needs?
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