S Corporations: What Are They?
An S corporation is a type of for-profit corporation that has a special tax classification
with the IRS. In all other ways, incorporating an S corporation is no different
from incorporating a C corporation—both
result in the formation of a new legal entity, separate and distinct from the individual
owners themselves and able to sue, be sued, and enter into contracts and agreements.
Other than tax treatment, an S corporation is operated in the same way as a C corporation:
an S corporation must follow the same corporate formalities necessary to protect
corporate veil. As with all corporations, the directors and officers manage
the operations of the S corporation, and corporate profits must be distributed per
the stock ownership ratio. (For example, a shareholder with 29% of the shares must
receive 29% of the profit, no more and no less.)
After incorporating with the state, a corporation has up to 75 days to file IRS
form 2553, the form by which it elect S corporation status. Some states, like California,
also have S corporation applications that must be filed with the Secretary of State.
What are the advantages and disadvantages of an S corporation?
An S corporation offers a lower tax burden than its C corporation counterpart, but
the trade-off comes in the form of a more rigid corporate structure.
An S corporation is known as a "pass-through entity," meaning that profits are "passed
through" to the individuals before being taxed.
In order to understand this concept, it helps to compare the tax structure with
that of a C corporation. With a C corporation, profits are taxed once at the corporate
level, and then again at the individual level when distributed to the owners. This
results in a large amount of corporate profit being taxed twice.
However, in the S corporation tax structure, since gains and losses are reported
only on the owning individuals' tax returns, much less money is lost in the form
of federal taxes.
While S corporations enjoy tax benefits, there are other restrictions and limitations
that typically make S corporations a good option for smaller corporations:
There may not be more than 100 shareholders;
Shareholders must be individuals who have US citizenship or are resident aliens;
Only one class of stock can be issued.
What are some other benefits of incorporating?
Forming either type of corporation enables you to take advantage of certain benefits
Shareholders enjoy limited liability from debts, judgments, or other obligations
of the corporation;
Unless corporate fraud is a factor, shareholders cannot typically lose any more
than the amount of stock they hold;
Corporations can raise capital by selling stock; and
Corporations may deduct the costs of benefits they provide to their officers and
employees, such as health insurance and monthly parking passes.
For more information
The following pages describe specific differences between business types.
For Information By State