As a small business owner, protecting your personal assets and your company is a high priority. Incorporation as an S-Corp allows you to do this, while minimizing your tax burden. If you are considering incorporation but don’t intend to go public, an S-Corp may be the right option for you. However, this tax-status significantly limits who may be a shareholder, the number of shareholders, and the stock classes that you can offer.
Weighing the pros and cons of an S-Corp can be overwhelming for business owners. Each form of business has its merits depending on your goals for your business and the way you operate. Discussing your options with an experienced corporate lawyer in the Priori network allows you to make an informed decision.
What is an S Corp?
An S-Corp (or S Corporation) is defined as a special form of corporation with limited liability and defined corporate structure that meets the IRS requirements to be taxed under Subchapter S of the Internal Revenue Code. Under this code, an S-Corp is taxed as a partnership, while reaping the legal protections and benefits of incorporation. Essentially, an S-Corp is a pass-through tax entity. S corporations pay no federal income taxes. Instead, the S corporation's income or losses are divided among the shareholders and reported on individual income tax returns.
Requirements to Qualify as an S-Corp
In order to qualify as an S-Corp under IRS regulations, your small business must meet the following requirements:
- It is a domestic corporation;
- There are no more than 100 shareholders;
- There is only one class of stock; and
- Only eligible shareholders are invested, including individuals, certain trusts, and estates.
Advantages of S-Corps
There are many advantages to incorporating as an S-Corp. The following are the three most important to most small business owners:
- Tax Savings. Income is passed directly to shareholders, so they avoid double taxation. In addition, those employees who are also shareholders can receive only a defined salary at market value taxed at the higher income tax rate. All other income is taxed as a distribution at a generally much lower rate.
- Existence Independent of Shareholders. The company is a legal entity separate from the shareholders, which means that if a shareholder leaves the company or sells shares, the corporation can carry on without much interruption.
- Liability Protection. Since the company is a separate legal entity than you as the owner, your financial liability is seriously limited (although not totally eliminated).
If you do elect to be an S-Corporation, you must file Form 2553 with the IRS in addition to a Certificate of Incorporation or Articles of Incorporation in the state where you form.
Depending on your state of incorporation, number of owners and investors, future plans and the number of corporate documents your lawyer needs to prepare, the cost of forming an S-corp can vary dramatically. When you hire a lawyer in the Priori network, forming your S-corp typically costs between $250-$2000. In order to get a better sense of cost for your particular situation, put in a request to schedule a complimentary consultation and receive a free price quote from one of our lawyers.
What is the difference between an S-Corp and a C-Corp?
Both S-Corps and C-Corps operate in similar manners and have similar corporate structures, but they are taxed differently. S-Corps pay not taxes directly, while C-Corps are separate taxable entities that file corporate taxes. In addition, S-corps can only have limited numbers and types of shareholders, while C-Corps do not have such limits. Generally speaking, a C-Corp offers you better options if you ultimately plan to solicit investment and/or go public.
Are there any risks in incorporating as an S-Corp?
If you incorporate as an S-Corp, you must comply with very strict procedural and operational requirements. Failure to do so could lead to tax and legal penalties. You also must reasonably compensate shareholders or risk higher employment taxes and IRS audits. While the S-Corp is not an inherently high-risk choice for most companies, you should discuss the specific risks you face with a CPA and a corporate lawyer.