What is an S Corporation?

In the United States, an S corporation is a type of corporation that is given special tax classification by the Internal Revenue Service (IRS). To qualify as an S corporation, a company must meet certain criteria and be approved by the IRS. S corporations are a popular choice for small businesses, as they provide many tax benefits that are not available to other businesses such as limited liability companies (LLCs) or sole proprietorships.

Advantages of an S Corporation

The primary advantage of an S corporation is that it can be used to legally avoid the double taxation of a traditional corporation. With a traditional corporation, profits are taxed twice – first at the corporate rate, and again when the remaining profits are distributed to the shareholders as dividends. With an S corporation, however, all profits and losses “pass through” to the shareholders without being subject to the corporate income tax rate. This makes S corporations an attractive option for businesses that want to minimize their overall tax burden or distribute profits among shareholders in a more tax efficient manner.

Another advantage of an S corporation is that it offers liability protection for the business and its owners. In most states, personal assets are generally safe from claims against the corporation as long as proper corporate formalities are followed. This means that if something goes wrong with the business, owners’ personal assets generally cannot be touched.

Setting Up an S Corporation

In order to set up an S corporation, a company must meet certain criteria set forth by the IRS. This includes having no more than 100 shareholders, only one class of stock, and at least one corporate officer. The corporation must also meet certain state registration requirements, and the individual shareholders must all be U.S. citizens or resident aliens.

Once the effort of meeting the IRS and state requirements has been completed, an S corporation can be created. The corporate structure of an S corporation is generally comparable to that of a traditional C corporation, meaning that the company must hold a board of directors meeting, take minutes, and file annual reports.

Tax Implications of an S Corporation

One of the most important tax benefits of an S corporation is the avoidance of the double taxation of corporate profits. As mentioned previously, with S corporations, profit and losses are “passed through” to the shareholders. This avoids the corporate tax rate and allows shareholders to report profits and losses on their individual tax returns, where they are typically taxed at a lower rate.

Another advantage of an S corporation is that the corporation itself does not pay Social Security or Medicare taxes. This can be a substantial savings for the business, as Social Security and Medicare taxes can add up quickly. Tax payments are also generally due sooner than with other types of corporations, as the S corporation must file an annual return but does not need to pay quarterly tax forms.

Conclusion

An S corporation is a type of corporation that is given special tax classification by the IRS. It offers many advantages for small businesses, most notably avoiding the double taxation of traditional corporations and providing liability protection for shareholders. Setting up an S corporation requires meeting certain IRS and state requirements, with taxes generally due sooner than with other types of corporations. For these reasons, many small business owners choose to form an S corporation.