One of the first decisions you’ll tackle when launching your own business is what kind of business entity you’ll create, such as a C corporation or limited liability company (LLC). You may have also come across the term “S corporation” (small business corporation) and wondered if the decision would be even more complex than you imagined.
Fortunately, the S-corp is not a business type, but rather an IRS classification that could save you a lot of money depending on your circumstance. And, unless you’re new to this planet, you know that taxes are an important consideration in business (and if you are new to the planet, we’ll cover that later in this article, at least in terms of how it would impact your S corp status).
What Is It, and Who Qualifies?
As stated above, an S corp is not a type of business entity, but rather a tax election status. So, you can be a C corp or an LLC and still file to be taxed as an S corp—you retain your original classification. Of course, certain requirements must be met.
An LLC can file to become an S corp if they meet the following conditions:
- The owner(s) are US citizens or resident aliens. (See? We told you we’d address the alien topic later.) In addition to individuals, the IRS will also accept “certain trusts and estates” as owners.
- There are fewer than 100 members.
A corporation has the same requirements, provided that they only have one class of stock.
Benefits of an S Corp
If your circumstances are right, there are numerous advantages to filing as an S corp:
- Pass-Through Tax Benefits – Depending on your tax bracket, you can keep more of the money you have earned for the business. The owners of the company report their share of profits and losses on their individual taxes.
- No Double Taxation – In an S corp, the corporation doesn’t pay taxes on its profits. Those profits are only taxed when they are distributed to individual shareholders. When a C corp makes a profit, however, the corporation pays taxes on both the corporate profits and gets taxed again when they are distributed to individual shareholders.
- Savings on Payroll Taxes – If you’re a shareholder in an S corp, you can be both an owner and an employee. As an employee, you’re taxed for Medicare and social security, but the money you make as a shareholder isn’t subject to those taxes. Consequently, sometimes shareholders who are also employees take a lower salary and compensate with a bigger share of dividends, knowing that they won’t have to pay taxes on the dividends. However, the IRS does look closely at these situations, so it’s still important to pay yourself a reasonable salary as an employee.
- Less Frequent Reporting – An S corp only requires annual reporting, while a C corp must estimate tax payments to the IRS quarterly.
- Liability Protection – Directors and officers of the company, as well as shareholders and employees, have limited liability protection.
Drawbacks of an S Corp
The above may sound good to you, but also consider that there are disadvantages that go along with filing for S corp status:
- More Involved Process – Filing as an S corp requires more paperwork from the IRS and also invites more scrutiny because payments to shareholders could come either in the form of salaries or dividends. Since each of those are taxed differently, the IRS keeps a close watch on the situation.
- Salary Requirements – Once the business becomes profitable, you’ll be required to pay yourself a salary. It’s important that the salary be in keeping with what someone in a similar position would earn and not too low, as the IRS carefully monitors salaries for owner-shareholders.
- Income Estimates – If you expect to owe $1,000 or more for the current tax year, you must make quarterly personal estimated income tax payments. However, this applies only if you are not withholding through payroll; if you are, you don’t need to worry about this requirement.
- Franchise Tax – Depending on the state you formed your business in, you may have to pay State S corp franchise tax…even if your business is not making a profit.
- Recorded Document Requirements – As an S corp, you’ll be required to have annual shareholder meetings, as well as appoint a board of directors that runs the company and meets regularly. Most states require minutes of these meetings to be recorded. Additional financial reports will also likely be required.
- Total Separation – You will need to maintain complete separation between yourself and the actual S corp, meaning you will need to keep your personal finances and the business’s finances completely apart. Otherwise, someone could challenge your business’s status as a separate entity.
- Not Good for Outside Funding – Because you’re limited to 100 shareholders and none of them can be a venture capitalist or some other entity, an S corp isn’t ideal for businesses that need to raise a lot of money quickly.
How to Become an S Corp
The easiest way to become an S corp is to file an S corp election and any additional LLC paperwork after successfully forming your business. This service is available from the personalized ZenBusiness dashboard for only $250. But if you’re more inclined to do it yourself, here are the steps to take:
File Your Business
– File the articles of incorporation and become an LLC or a corporation, if you have not done so already.
Appoint a Registered Agent
– We offer our registered agent service for only $110 per year.
Elect a Board of Directors
– Shareholders must appoint this board to run the company.
Issue Stock or Membership Certificates
– Share these with all shareholders or business owners.
Create Corporate Bylaws or an Operating Agreement
– Though not required by every state, it’s wise to have these from the start.
Obtain Your EIN
– Request your Employer Identification Number (EIN) with the IRS and be sure to notify them of your intention to become an S corp.
File Your S-Corp Election
– Complete form 2553 with the IRS to confirm your S corp election and mail it to them via certified mail. You can find instructions for completing this form here
Additional LLC Forms
– If you have an LLC, you’ll also need to prepare and file Form 8832 along with Form 2553 and mail both via certified mail to the IRS.
Taking all of the above into consideration, does filing to become an S corp make sense for your business? Will it save you money in taxes and, if so, enough to offset the required paperwork and hassle? If you have additional questions before you make a decision, contact ZenBusiness today.