Whenever a business owner considers incorporation, they usually tend to immediately lean toward creating a limited liability company (LLC). This is only natural, considering LLCs are the most widely used designation for today’s companies. But settling on a simple LLC without any deeper analysis is hardly your only option. Have you at least explored the possibility of creating an S Corporation?
We know what you might be thinking: “What is an S Corporation?” While not nearly as ubiquitous as LLCs, S Corporations share many of the same characteristics, though this type of business bears its own distinct advantages. Today, we’ll discuss what an S Corp is, how it differs from an LLC and what benefits you could enjoy as the owner of such a company. After all, only by understanding all your options can you make a knowledgeable decision and truly maximize the potential of your business.
S Corporations Explained
One of the biggest drawbacks of running your own company is the complicated tax seasons you’ll face as a result. In accordance with your (hopefully) rising profits, your tax rate will only increase as you become more established…but forming an S Corporation can help offset that. Also known as a “subchapter corporation,” an S Corp allows you to maintain flexibility in the ownership structure of your business without sacrificing the inherent tax advantages that such an organization can provide. The concept of an S Corporation was passed into law back in 1958 to bolster the creation of small businesses, protecting them from strict tax codes that apply to most other companies.
First, S Corps are far more lenient than C Corporations when it comes to corporate income taxes. Like an LLC, S Corporations serve as pass-through entities for tax purposes — but the treatment its owners receive does not extend to tax liability for the company itself. Rather, your business income flows directly into shareholders’ personal income tax returns. To that end, S Corps are also confronted with far fewer limitations when it comes to managing the ownership structure. Shareholders can transfer stock (but, notably, not interest) after securing the approval of the other shareholders.
Even though designating your company as an S Corp can be useful, certain restrictions may prevent you from leveraging this approach for your own business. For example, if your company has more than 100 shareholders, is technically an international business entity (or its shareholders are made up of non-U.S. citizens) or bears more than one class of stock, then the option for an S Corporation simply is not available to you. In that case, an LLC or other C Corporation is the best option. Yet for those who qualify, the prospect of S Corporation taxes alone make it a worthwhile route.
The S Corp’s Competitive Edge
Now that you have a better understanding of what an S Corp is, let’s dig a little deeper into the competitive advantages that filing your business as an S Corporation can bring. While the full scope of the impact will depend on the details of your business, here are the three most commonly recognized S Corporation benefits:
- Maintains pass-through taxation: We’ve already alluded to this, but the way S Corps are treated for taxes is definitely the highlight of this particular entity. Perhaps the most noteworthy aspect is that S Corps do not pay any corporate taxes. Rather, as mentioned above, all profits or losses are reported based on your own personal income taxes, allowing S Corporations to sidestep the double taxation that some LLCs and other C corporations must overcome. As long as shareholders working for an S Corp pay themselves a reasonable salary, their tax liability is greatly reduced since that share of income will not incur self-employment taxes.
- Unlimited lifespan: If you ever decide to leave your company, your S Corp will continue to operate as normal — transferring ownership is as easy as selling the company stock. There’s no need for corporate restructuring or any other alterations to your incorporation status. Unlike some other types of business entities, your S Corporation retains a stable architecture even after it changes hands, protecting your company’s long-term future. Conversely, if you find that S Corp status isn’t a good fit for your business, you can change it at any time.
- Enjoy reduced taxable gains: If you do sell your company at some point, another tremendous S Corporation advantage is that you won’t be burdened by high taxable gains. This type of company typically has lower taxable gains than C Corporations, meaning that you may be able to pocket some extra cash when all is said and done.
The Latest on S Corps
Even though your familiarity with S Corporations may have been lacking before today, the prevalence of this type of business entity continues to rise, as evidenced by the increasing legal support it is receiving. This past year, a new tax reform law — dubbed The Tax Cuts and Jobs Act — declared that pass-through entities such as S Corps would receive a 20 percent deduction on qualified business income. Such a move only intensifies the inherent attraction of S Corporations, and it’s likely to boost the number of business owners who decide to take their companies down this path.
Of course, be sure to weigh all the pros and cons before deciding if an S Corp is the right fit for your business. Many factors play into which type of entity makes sense for your corporate structure, your business finances and your plans for the future. So before you make any concrete plans one way or another, explore all your options — or think about reaching out to a qualified professional to confirm whether your company is ideally suited for S Corporation status.
At Incfile, we work with startups all the time, so we know the decisions you have ahead of you. Identifying which type of entity fits your business model best is perhaps one of the most critical parts of starting your own company. For instance, many would-be LLCs who discover the largely-untapped power of S Corps will choose to take their business in a completely new direction. But you don’t have to face these corporate crossroads alone. Our goal is to shepherd new startups and small businesses, ensuring that they get off to the best possible start and optimize their chances for success. If you’re ready to get serious about your business, visit our website and let’s get started!
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