When you’re establishing a corporation, you have a lot of choices to make — and the decisions you make at the beginning can have long-standing effects on the future of your business. Tax savings are often a priority for small business owners and startup founders, and S corp status may seem like an appealing solution.
You may significantly benefit from the unique advantages of utilizing an S corp structure if you’re able to do so. Before choosing an S corp, here’s what you should consider and how Mosey can work to keep your S corp compliant with state laws.
What Is an S Corp?
An S corporation is a corporation that chooses to pass profits, losses, deductions, and credits through its members or shareholders rather than through the corporation itself. Everything is accounted for but distributed between people who share the responsibility of maintaining the S Corp.
Due to its federal tax classification, S corps avoid double taxation by legally bypassing business tax requirements. You’re still paying all the taxes you legally owe — you’re simply electing to do so in a different way. Everything is accounted for on individual tax returns, and liability is equitably divided among each shareholder’s share of taxable income.
Only certain corporations are eligible to become S corporations. Corporations must meet all requirements to be legally regarded as S corp for federal tax purposes.
What Is the Eligibility Criteria for an S Corporation?
S corporations must be domestic corporations with only one class of stock. They must be an eligible type of corporation. Most domestic international sales corporations, several types of financial institutions, and insurance companies of any kind are not eligible to become S corporations.
Since an S corporation passes its profits, losses, and deductions through its shareholders, the strictest eligibility criteria reside within the shareholder rules. An S corporation may not have more than 100 shareholders. Partnerships, LLCs, and certain other entities do not qualify as eligible shareholders. In some cases, estates or trusts can act as S corp shareholders.
Nonresident alien individuals or business entities cannot act as shareholders for an S corporation because non-resident people and entities are subject to different tax rules. This does not mean shareholder roles are reserved exclusively for U.S. citizens. Any lawful permanent resident (green card holder) is eligible to act as a shareholder for an S corp throughout the duration of their lawful permanent resident status.
An S corporation is established through many of the same formal processes used to establish most other types of corporations. The biggest difference resides in the required consent of all eligible shareholders.
An S corporation cannot be established by a majority vote. Every single shareholder of an S corporation must agree to treat the corporation as an S corporation. All members and shareholders are required to sign and submit a proposal to the IRS called Form 2553, Election by a Small Business Corporation.
Ownership of an S corporation can change quite frequently. Anyone who purchases stock is considered a member of the S corporation and must be added to the list of eligible owners. Anyone who sells all of their stock in an S corporation is considered to have left the corporation and can be removed from documents.
What Are the Advantages of Using an S Corp?
Although an S corporation is not the most conventional structure, it has the potential to become the most advantageous if its structure aligns with your corporate goals. It’s important to discuss utilizing an S corp structure with a tax professional before you make any final decisions.
These are some of the talking points you may want to raise:
An S Corporation is Nearly Immortal
S corporations never have to formally change hands. If someone were to pass away or sell all their shares, the remaining members and interested buyers would become the new shareholders.
An S Corp is highly dynamic. S corporations could theoretically continue forever through a process of continued addition and subtraction of members.
Members Have Liability Protection
The corporate structure shields members from liabilities and debts associated with the S corporation, which protects the personal assets of everyone involved. In most cases, S corporation members may not be pursued directly for debts or damages.
S corporation shareholders assume personal accountability in an S corp, down to filing personal tax returns. Responsibility is clearly individualized, which reduces the chances that a misstep of one person may have a negative impact on everyone else.
Trustworthiness
An S corporation may be viewed more favorably than a sole proprietorship because the scope of the operation is larger. Every shareholder provides an additional level of accountability, which may make your corporation appear more credible. Raising capital as an S corporation is even easier because it’s as simple as selling shares or bringing another member on board.
Reputational advantage and a faster path to financial growth leave greater room for innovation and expansion. Credibility advantages and ease of obtaining capital may help you grow at a steadier pace.
Pass-Through Taxation
Because every financial aspect, from income to business deductions, is proportionately passed through to shareholders, income is never taxed twice. S corporations are not required to pay corporate income tax.
Members file federal income tax for themselves every tax year. All the S Corp needs to do is divide the tax liability appropriately.
What Are Some FAQs About S Corporations?
It’s important to consider every aspect of an S corporation carefully before forming one. These are important matters to consider before you make any major commitments.
How do you form an S Corporation?
You can’t form an S corporation outright. You must first form a business entity under another structure and then elect to become an S corporation for tax purposes. An S corporation is a destination rather than a starting point.
Can only corporations become S Corporations?
Most S corporations begin as other types of corporations, but many other business entities can elect to become an S corporation if they meet the eligibility criteria. You can turn a Limited Liability Company (LLC) into an S corporation if you choose to do so.
Do I have to register my S Corporation with the state?
An S corporation election is specific to the IRS. You’ll only need to file for S Corporation status with the IRS for tax purposes. You don’t need to change your designation with the state where your business is registered.
The shareholder maximum limit is 100 shareholders, but there is no minimum number of shareholders. Two people can form an S corporation as a duo because there is significant room for growth. If you want to add new members to your S corporation, you only need to sell them at least one share of the corporation.
When can a business entity become an S Corporation?
A business entity can become an S corporation after filing Articles of Incorporation and the completion and filing of Form 2553, Election by a Small Business Corporation. If Form 2553 is accepted and all eligibility requirements are met, a business entity successfully becomes an S corp.
What taxes do S Corporations pay?
There is no federal corporate tax on an S corporation because the corporation is used as a pass-through entity. Sometimes, an S corporation will have to pay taxes on certain types of gains and designated passive income streams. Although there are no federal S corporation entity taxes, some states (such as California) impose taxes on local S corporations.
It’s best to check your local laws and consult with a local tax professional for detailed guidance.
Should I form an S Corporation?
Your preferences and needs should be thoroughly considered when deciding whether or not an S corporation is the right choice for your business. The right answer is whichever answer feels best to you and other key players in your business. Most people choose an S corporation because they enjoy the tax advantages.
What are the compliance requirements for an S Corporation?
An S corporation is intended to work similarly to a C corporation. They’re nearly functionally identical entities aside from the way that taxation is approached.
S corporations must maintain a current list of shareholders, write up corporate bylaw, appoint directors, and hold votes with shareholders before any major business decisions are made. Maintaining an S Corp requires a significant amount of corporate formality that wouldn’t be necessary with a structure like an LLC.
Staying Compliant with Mosey
There are many advantages to utilizing an S corp business entity, but a significant amount of compliance issues require your constant attention. That’s where Mosey can become the most valuable tool in your corporate arsenal.
Mosey’s compliance management platform makes it easy to keep track of state S corp requirements. You can focus on communicating with your shareholders and strategizing for the future while Mosey runs in the background. Schedule a demo with Mosey to learn how our compliance solutions can simplify your S Corp.
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