According to the Internal Revenue Service, S corporations pass income, losses, deductions, and credits to shareholders. Learn more in this in-depth overview, including examples and comparisons.
Entrepreneurs have two main goals when choosing a business structure:
- Protect their personal properties from business claims
- Reduce their tax burden considerably
An S corporation business structure provides the right balance of tax benefits and legal protection. While an S corporation is required to have a board of directors, they enjoy limited liability protection and pay taxes as sole proprietorships and partnerships.
Read on to learn what an S corporation is, how to form an S-Corp, how an S Corp differs from a C Corp, and tools to make an S Corp successful.
What Is an S Corporation?
According to the IRS, S corporations are “corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.”
For a business to become an S corporation, it must meet the following requirements:
- The number of shareholders must not exceed 100.
- The business should have only one class of stock.
- All shareholders must be U.S. citizens.
- The corporation must do business only within the U.S.
- The business should not be an ineligible corporation.
Starting an S corp benefits owners with a pass-through tax structure. Instead of getting taxed at the corporate level, S corps are taxed once at the shareholders’ income. This prevents double taxation and high tax rates.
C Corporation vs. S Corporation: What's the Difference?
Unlike S corps, C corps enjoy an unlimited number of shareholders who can be businesses inside or outside the United States. C corps and S corps also differ when it comes to federal taxation. C corps are subject to double taxation. First, they taxes at the corporate level, then shareholders pay personal income tax at the individual level. An S corp is taxed once only at the shareholders’ personal income. It doesn’t pay corporate taxes.
How to Form an S Corporation
Follow these steps to form an S corporation.
1. Form an LLC or Corporation
Start by choosing a business name for your corporation or LLC and registering with the relevant state agency (usually the Secretary of State). The name should reflect your brand’s identity, be unique, and comply with all applicable naming requirements in your state.
Next, fill out your state’s required formation documents. These documents will be articles of organization (for an LLC) or articles of incorporation (for a corporation).
Here are the basic details necessary to fill these documents:
- List of shareholders or members of the board of directors
- Business name and address
- Business purpose
- Value of shares
File the documents with your state.
2. Acquire a Federal Tax ID Number
Before forming an S corp, you will need a tax ID number, also known as an Employer Identification Number (EIN). The IRS assigns federal tax ID numbers to all businesses. After forming your LLC or corporation, apply for a free EIN on the IRS website.
3. Review S Corporation Election Requirements
For your business to be eligible for S corp status, it must meet these requirements:
- Your business entity must only offer one class of stock.
- The business entity must have 100 or fewer shareholders.
- Shareholders must be U.S citizens (with permanent residence) and can’t be corporations or partnerships.
- Your business cannot be an ineligible corporation, which includes certain insurance companies, domestic-international sales corporations, and financial institutions.
4. File S Corporation Election Paperwork
After confirming your business entity meets the requirements, make it an S corp by filing Form 2553 (Election by a Small Business Corporation). Filing Form 2553 is subject to time, so ensure you file it at the correct period specified by the IRS:
- Within two months and 15 days after the beginning of the tax year that you want the form to take effect
- Any time in the current tax year preceding the tax year that you want Form 2553 to take effect
You don’t need to renew S corp status annually. However, you must ensure the business continues to meet S corp shareholder and stock requirements. If it doesn’t, the IRS will tax it as a C corp or LLC.
What Changed for Boards in 2022?
Frequently Asked Questions
What Are the Benefits of an S Corporation?
An S corporation avoids double taxation and protects owners from liabilities.
What Are the Disadvantages of an S Corporation?
An S corporation comes with more stringent tax obligations, and formation plus ongoing expenses cost more.
How Many Shareholders Can an S Corporation Have?
An S corporation can have a maximum of 100 shareholders.
Does Your S Corporation Need a Board Management Solution?
Once you’ve successfully formed an S corporation, make sure the corporation steers in the right direction. S corps must have a board of directors who oversee company management.
To streamline board leadership and improve board effectiveness, your S corporation needs a robust board management solution like OnBoard. OnBoard’s powerful features allow board members to achieve the following:
- Hold effective meetings virtually on a secure platform.
- Securely store crucial board documents so board members may access them at any time.
- Organize, track, review, and approve decisions through a voting system.
- Stay on track with task management.
About The Author
- Josh Palmer serves as OnBoard's Head of Content. An experienced content creator, his previous roles have spanned numerous industries including B2C and B2B home improvement, healthcare, and software-as-a-service (SaaS). An Indianapolis native and graduate of Indiana University, Palmer currently resides in Fishers, Ind.
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