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Choosing to Incorporate as an S Corporation

An "S" corporation is a company that forms as a C corporation and then chooses special tax status that makes it a "pass-through" entity, like an LLC. And S corporations' profits and losses can be passed directly to the owners without first being taxed at the corporate level, because, unlike a C corp., an S corp is not a separate taxable entity. Thus, choosing S status eliminates the double taxation issue faced by owners and shareholders of C corps.

To become an S corporation, you must first file as a regular C corporation, as the articles of incorporation you file with the state are the same for both the C and S corporations. Once the state in which you're incorporating sends you back your paperwork, you fill out an IRS form 2553 ("Election by a Small Business Corporation) and send it in to the IRS.

What Are the Benefits of Electing S Corporation Status?

Electing S corp status confers a number of benefits. These include:

Corporate profits pass through directly to owners without being taxed at the corporate level.

As with a C corporation, an S corp is said to have a lower risk of being audited by the government than other pass-through business forms, such as sole proprietorship or LLCs.

Owners, directors and employees are protected from liability for the liabilities, obligations and debts the business incurs: In a number of states, this limited liability applies even if only one individual owns all the stock in the S corporation, and acts as its only employee.

Owners can use the corporation's losses to offset income.

They also can lower employment taxes by taking distributions rather than salary.

What Are the Negatives of Electing S Corporation Status?

Although similar in many ways to other pass-through entities, such as LLCs, S corp status requires more paperwork and more formalities, such as filing a yearly informal return that indicates earnings, losses and how much of each belongs to each partner in the corporation.

Income must be allocated to owners according to their ownership interests.

A number of states levy a minimal (usually 1% to 2% of profits) Franchise Tax on S Corporations; this is not so for LLCs.

S corps are not allowed to provide as many fringe benefits as a C Corporation.

Unlike C corps, S corporations cannot have unlimited shareholders; 100 is the maximum number of shareholders allowed.

Although owners can deduct business losses against other income, an active owner can only do so the extent of their loans to or investment in the S corporation.

What Documents Do I Need to Form an S Corporation?

You'll need the same documents as for a C corporation (articles of incorporation, bylaws, organizational board resolutions, stocks certificates and a stock ledger), PLUS one more: the IRS form 2553 ("Election by a Small Business Corporation). As mentioned above, this is filed with the federal government after you receive back the other documents of incorporation from the state.

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Information here does not constitute a legal advice. Please contact an attorney or accountant for specific expertise.

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