“S corporation” stands for “Subchapter S corporation”, or sometimes “Small Business Corporation.” It’s a special tax status granted by the IRS (Internal Revenue Service) that lets corporations pass their corporate income, credits, and deductions through to their shareholders. S corporation is the other name for S subchapter which permit income to the shareholders, along with additional credits, deductions, and losses straight to the shareholder.
S corporation is a special type of corporation that’s designed to avoid the double taxation disadvantage of regular C corps. S corps allow profits, and some losses, to be passed through directly to owners’ personal income without ever being subject to corporate tax rates.
People generally wonder what is the relation between S corporations and limited liability companies (LLCs). They are in some ways similar business structures. Technically, neither of them pays taxes. Instead, their net taxable income is taxed to the company’s shareholders on their personal tax returns. And both are separate legal entities, which means the owners have liability protection and their personal assets are protected.
The differences between S corps and LLCs include:
- LLCs can have an unlimited number of members: an LLC can be a single-member LLC or a multi-member LLC with unlimited shareholders, but an S corp is limited to 100 shareholders.
- LLCs can have non-resident alien shareholders: S corps are not permitted to have any non-US citizens as shareholders.
- LLCs can be owned by corporations, partnerships, trusts, or other LLCs
How do we know the basics about an S Corp- A small business may operate under various legal measures. These small businesses generally are under sole proprietorship. The individual who owns the business receives all of its income and is responsible for all the business’s debts—including other liabilities to which the business may be subject. In the case of S corps, a sole proprietorship, the individual and the business are the same thing. If the business fails, the owner may have to sell his or her house and other goods to satisfy its debts. The principal advantage of incorporation is that the owner as a person is separated from the corporation, the latter viewed as an artificial “person.” They are now two, not one. The corporation carries its liabilities. When the corporation fails, the liability of its owners is limited to whatever they have invested—and no more.
Pay Vs. Profit-Sharing
S corporations must be careful to pay stockholders who work for the corporation salaries “deemed reasonable” by industry standards. The temptation exists to pay stockholders low salaries and to compensate them, instead, from profits—thus avoiding payroll taxes. But if the stockholder-employee is not paid at a reasonable rate, the IRS may require the stockholder to pay payroll taxes on the totality of the income received from the S corporation—which may be substantial.
State and Local Taxes
S corporations are sanctioned under federal tax laws, which may not be matched by local and state governments. Thus, S corporations may still have to pay taxes as corporations to states and localities.
S corporations must maintain careful records. This is not, a disadvantage of the form: after all, all businesses should keep good records. But some business owners see the S corporation as merely one way to escape liabilities by gaining the benefits of limited liability while continuing to operate as sole proprietors.
Under prevailing law, a corporation (S or C) must adhere to regular forms:
it must separate personal from corporate accounts,
hold regular directors’ and shareholders’ meetings, take minutes,
use the appropriate corporate designation on its documents and stationery.
Failing to adhere to these requirements, the S corporation may end up with the result that the stockholders are severally and individually held to be liable.
TERMINATING S CORPORATION STATUS
An S corporation may voluntarily revoke its status if it finds that S status is no longer beneficial; it may also lose the status involuntarily. In the first case, a majority of the stockholders are required to make the decision, and a simple notice to the IRS is all that is required. In the second case, any act which disqualifies the corporation’s eligibility for S status will result in the termination of that status effective on the date that the infraction occurs. An example of such a disqualification would be acquiring a single foreign stockholder living abroad.
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