Having a successful small business is a dream come true for many Americans. When your company starts growing, you may want to consider forming an S-Corporation, or S-Corp. This business entity has the tax advantages you need, with the ownership flexibility you want.
The S-Corporation, or S-Corp, also known as the subchapter or small business corporation, is a tax code that was created and enacted into law by congress in 1958. It was created to encourage small and family business creation, while eliminating the double taxation that conventional corporations were subjected to.
Unlike traditional C-Corporations, or C-Corps, the S-Corporation is not subject to corporate income taxes. The S-Corporation is essentially a tax designation that is recognized by the IRS. Similar to the LLC the income generated by an S-Corporation will flow through to the personal income tax returns of the shareholders meaning that the entity is not required to pay taxes on a corporate.
The stock of S-Corporations is freely transferable, while the interest (ownership) of LLCs is not. This free transferability of interest means the shareholders of S corporations are able to sell their interest without obtaining the approval of the other shareholders.
In the area of self-employment taxes, an S-Corporation can have an advantage over an LLC. The compensation (salary and bonuses) of S-Corporation shareholders is subject to self-employment tax, but not on the profits automatically allocated to them as a shareholder.
In addition, the S-Corporation must adhere to the following limitations:
S-Corporations are exempt from federal income tax except for certain capital gains and passive income. Similar to the LLC, the S-Corporation allows for pass through profit to its shareholders. The profits of the S-Corporation are taxed at the individual tax rates of each shareholder’. The pass-through nature of the S-Corporation ensures that the corporation’s profits are only taxed one time – at the shareholder level. S-Corporations therefore avoid what is often referred to as “double taxation” of dividends.
S Corporation tax election status is obtained by the filing of IRS Form 2553 within 75 days of the filing date of the company or by filing the IRS Form 2553 by March 15 of each year.
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