Table of Contents

Introduction

When starting a business, one of the critical decisions to make is choosing the right structure. S Corporations (S Corps) are a popular choice for corporate businesses in the United States. This guide will help you understand what an S Corporation is, its benefits, drawbacks, and how it compares to other business structures.

Main Concepts

An S Corporation is a closely held corporation that chooses to be taxed under Subchapter S of the US Internal Revenue Code’s Chapter 1. Unlike traditional corporations, S Corporations don't pay taxes on corporate income. Instead, profits and losses are passed through to shareholders.

An S Corporation can have no more than 100 shareholders, all of whom must be US citizens or permanent residents. It cannot be owned by another corporate entity. S Corporations must be governed by appointed boards of directors and abide by sets of corporate bylaws, which are strictly regulated by federal and state agencies.

Step-by-Step Guide

To qualify as an S Corp, your business must meet certain requirements set forth by the Internal Revenue Service (IRS) and state tax authorities. These include:

  1. Your S Corp must be a domestic company based and operating in the United States.
  2. Your S Corp’s shareholders must be permitted under the IRS. They must be actual people, not partnerships or other corporations.
  3. Your S Corp may only issue a single class of stock.
  4. Your S Corp may not be an insurance agency, a bank, or a designated domestic international sales corporation.
  5. Your shareholders must unanimously consent to electing S Corp status.

In-Depth Discussion

There are several advantages and disadvantages to forming an S Corp. The primary benefit is avoiding double taxation, as the S Corp structure allows you to pass tax obligations onto shareholders. However, S Corps face limitations on the number of shareholders and the type of stock they can issue. They also face heightened scrutiny from federal tax authorities due to the tax advantages they offer.

Forming an S Corp can be time-consuming and costly due to the requirements of forming a default C Corporation or LLC before electing S Corp status. Therefore, it's essential to understand all the benefits, drawbacks, and implications ahead of time.

Review Section

When comparing S Corps to other corporate entities, it's important to note that they share some similarities but also have key differences. Like C Corporations, S Corps are funded through the issuance of stock, require appointment of corporate officers, and shield shareholders from corporate liability. However, S Corps are limited to 100 shareholders, can only issue a single class of stock, and pay taxes only on employee wages.