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An S Corporation is simply a standard corporation that becomes an S Corporation when it elects special tax status with the Internal Revenue Service (IRS) by filing an IRS Form 2553 after filing its official documents.
Like a C Corporation, an S Corporation is recognized by the law as an individual entity, separate from its shareholders (owners), many times treated as a human being.
Shareholders enjoy limited liability for the debts, obligations and liabilities incurred by the business as well as liability stemming from possible legal action. Protection of shareholders’ personal assets is one of the major reasons business owners choose to incorporate. Normally, shareholders cannot lose more than the amount they invested in the corporation. If the corporation goes bankrupt, the shareholders will not be liable for its debts. Should someone sue the corporation and the corporation is found liable, they can take the corporation’s property to satisfy the judgment but if that property does not satisfy the judgment, they will not be able to take a shareholder’s personal assets, i.e. home, car, bank account. An exception to a shareholder’s limited liability happens when the corporation has recklessly harmed people or has been used to perpetuate a fraud.
S Corporation Taxation
Unlike a C Corporation, the S Corporation does not itself pay any income taxes. While an S Corporation with more than one shareholder does file tax returns, the individual shareholders (owners) must include their share of the corporation’s income or loss on their personal tax returns, just as is done in sole proprietorships, partnerships and Limited Liability Companies (LLC’s).
Why Form an S Corporation?
S Corporations are for those who want the limited liability and the more formal structure of a corporation but with pass-through taxation of the business profits.
Official documents, typically called a Certificate of Incorporation or Articles of Incorporation, must be filed with the appropriate state in order to form an S Corporation, in addition to the IRS Form 2553. MaxFilings can help you with this.
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Some Points to Consider When Forming an S Corporation
- After filing official documents, typically called a Certificate of Incorporation or Articles of Incorporation, with the appropriate state, an IRS Form 2553 electing special tax status must be filed with the IRS.
- State filing fees must be paid
- An S Corporation is considered by the law to be an individual entity,
- separate from its owners (shareholders)
- There can be some limitations as to the kind of business a corporation is allowed to conduct
- You must hold and keep minutes that document meetings of the stockholders and board of directors
- An S Corporation cannot have more than 100 shareholders S Corporation shareholders cannot be other corporations, Limited Liability Companies (LLC’s), partnerships, certain trusts, or non-resident aliens
- Shareholders normally enjoy limited liability and can lose no more than the amount they invested in the corporation
- Shareholders cannot normally be held liable for legal judgments against the corporation or for any of the corporation’s debts or obligations
- Protection of shareholders’ personal assets is one of the major reasons business owners choose to incorporate
- Shareholders can be held liable when the corporation has recklessly harmed people or has been used to perpetuate a fraud
- It can be easier to get additional capital than with some of the other types of business since you can issue and sell stock or a variety of other financial instruments as evidence of interest in the corporation
- The sale of stock is sometimes subject to state and federal securities laws
- Ownership can be transferred by selling stock in the corporation
- While voting rights can differ, an S Corporation can have only one class of stock
- S Corporations are normally audited less frequently than sole proprietorships and partnerships
- S Corporations enjoy pass-through taxation so shareholders avoid so-called double taxation
- The S Corporation files informational tax returns but pays no income tax itself
- Shareholders report their share of both income and losses on their personal tax returns so they are able to use losses to offset other income
- Income and losses must be allocated based upon ownership percentages
- There can be limitations on certain fringe benefits for major shareholders
Owners & Employees
- Owners’ self employment taxes do not apply to salaries they are paid by the corporation
- Owners working in the business are employees and are therefore eligible for certain fringe benefits such as group insurance plans, retirement and profit sharing plans, and tax-favored stock option and bonus plans
- Employees frequently prefer to work for a corporation that can offer them stock options and stock bonuses
- In a sense a corporation is immortal and perpetual since it does not end with the death of a shareholder owner as do some of the other business types
- The general public normally thinks of S Corporations as being more substantial than sole proprietorships and partnerships