For entrepreneurs ready to start a corporation, navigating the benefits of different business entity types can be tricky. Between a Limited Liability Company (LLC), C Corporation (C Corp), S Corporation (S Corp), and Nonprofit, it may be confusing to decide what is the best route for your company.
Although forming an LLC has become one of the most familiar options for entrepreneurs when first starting out, an S Corp is also a popular choice among small business owners — and here’s why.
For small businesses, an S Corp offers tax advantages and liability protection while preserving ownership flexibility. This allows business profits to pass through to the shareholders’ personal tax returns — meaning that entrepreneurs are protected from the double taxation C Corp owners incur. In fact, the S Corp was specifically enacted into law in 1958 to help foster and encourage the creation of small businesses.
C Corps vs. S Corps for Small Business Taxes
As mentioned, C Corp owners incur double taxation, since they are subject to corporate as well as personal income taxes. But an S Corp receives different tax treatment that is generally more favorable to the business owner. Similar to an LLC, the S Corp is considered a pass-through entity for tax purposes.
Unlike an LLC, an S Corp also offers this wonderful benefit: the ability to pay yourself a salary! To make the most out of S Corps, business owners should pay themselves a reasonable salary, which will be subject to affiliated to payroll taxes. But that means any owners' withdrawals or dividends you take out of the company are free of employment taxes and not subject to a corporate tax rate.
Other Benefits of an S Corp
There are other benefits of choosing an S Corp for your small business entity type, including flexibility for managing the ownership of the business. This means an owner can sell their ownership interest without receiving approval from the shareholders.
Asset protection for an S Corp works similar to an LLC — you have certain legal protection for your personal assets, since they are legally separate from your business assets.
Though an S Corp does have many benefits, that doesn't mean it's the right choice for every small business. Make sure to do additional research to see if another entity type would be a better fit for your business needs and growth plan.
Form Your S Corp Today
If you decide that an S Corp is the route for you and your small business, there are a couple of items to note.
First, an S Corp must adhere to the following limitations:
It may not have more than 100 shareholders
It is required to be a domestic business entity
The shareholders of the S Corporation must be U.S. citizens or legal residents of the United States
The S Corporation is restricted to only one class of stock
As with any formal entity, it’s important to keep careful records in the event of an IRS audit. But with an S Corp, proper documentation can mean significant legal salary savings. When setting up your company, the only difference between an S Corp and any other entity type is making your selection on IRS Form 2553.
Need help forming and then managing your S Corp? Incfile is here to help! If you're wondering how much an S Corp election can really benefit your bottom line, use our handy S Corporation Tax Calculator to find out.
Lisa Crocco is a marketer for an international food manufacturer by day and a freelance writer/marketer for startups and small businesses by night. She's written for outlets like USA Today College, Career Contessa, CloudPeeps and Fairygodboss.