Deciding how to legally structure your business is one of the most important decisions you will make for your company. There are many options available, but one possible way to structure your business is as an S corporation, or S corp. Corporations come with many benefits — the primarily one being that the business becomes its own entity, thus relieving business owners of personal liability.
While this type of business entity isn’t right for everyone, it is beneficial for small domestic companies that don’t intend to borrow money. Here’s everything you need to know about S corporations.
What is an S corp?
An S corporation is a small business that elects to be taxed under Subchapter S of the Internal Revenue Code. This tax designation enables corporations to pass their corporate income, credits and deductions through to their shareholders. The shareholders divide the profits or losses amongst themselves, and the income is reported on their individual tax forms.
This structure helps corporations avoid double taxation, which is when a business is taxed at both the corporate and individual levels. The IRS requires S corps to pay going-rate salaries to the owners in order to avoid having to pay income or self-employment taxes.
[Read: What Is a C corporation?]
Advantages of starting an S corp
There are many reasons why an S corp can benefit a business. One of the most attractive things to businesses is the fact that having an S corp avoids double taxation. S corps can make distributions to the owners that do not require an income or self-employment tax. An S corp’s revenue is only taxed when it is paid out as dividends to shareholders, which can save the business a great deal of money.
Another major attraction is limited liability protection. Owners of an S corp are not held personally liable, but rather the business as its own entity takes on liability. The owners gain security of their personal assets. Additionally, if the owners were to leave the business or pass away, the business could still continue to run as usual.
S corps can also attract various investors through selling stocks. These investors, or shareholders, will be liable for the amount they invest in the business. Another benefit to being an S corp is that they only have to file once a year instead of every quarter, like C corps.
If your business seeks to remain small, with only U.S. individual shareholders and no future need to borrow money, you will most likely benefit from being an S corp.
Requirements of an S corp
According to the IRS, there are certain requirements to becoming and remaining an S corp. The business must:
- Be a domestic corporation.
- Only have allowable shareholders that include individuals, certain trusts and estates that are not partnerships, corporations or non-resident alien shareholders.
- Not have more than 100 shareholders.
- Only have one class of stock.
- Not be an ineligible corporation, such as an insurance company or domestic international sales corporation.
If your business grows beyond the scope of a small business, it may be difficult to remain within these parameters.
Is an S corp right for your business?
If your business seeks to remain small, with only U.S. individual shareholders and no future need to borrow money, you will most likely benefit from being an S corp. While an LLC, on the other hand, is more flexible and better to have when there is debt, an S corp is less expensive and complex to form and maintain.
According to Corporate Direct, an S corp is great for businesses that:
- Will provide a service.
- Will not have significant startup costs.
- Will not need to make major equipment purchases before beginning operations.
- Will not make a sizable amount of money without a great deal of effort and expense.
No matter what business structure you choose, it is always important to research the advantages and disadvantages before making a decision. There is always a chance to change your status after your initial decision if you decide a different structure is a better fit.
[Read: Getting Ready to Launch? How to Choose the Right Business Structure]
CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.
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