Corporations are not limited to professionals with unlimited resources and knowledge about the infrastructure about business. Most people do not realize that there are many types of entities beyond partnerships and sole proprietorships. The sub chapter S-corporation is a commonly used business in the United States due to the benefits that it presents to shareholders and officers. Even though S-corporations have special payroll and shareholder requirements, the entity is still popular among people that are looking for special tax advantages. Having the right business entity can help a business owner be successful and prolong the life of the business.
Corporations are established by filing Articles of Incorporation or Certificates of Incorporation with the state which they reside. The business is governed and protected by the state where it operates business. Organizational Minutes and By Laws describe how the business will operate and shares of stock represent ownership in the company. The shares are not publicly traded but they can be sold by the owner in exchange for ownership in the business. However, business owners should consult a financial advisor before engaging in such a transaction. The business must register with the IRS by obtaining a Federal Employer Identification Number shortly after becoming incorporated. The FEIN acts as a social security number for the business and must be used on all tax and legal forms for the business. Corporations are automatically C-corporations unless they elect to be taxed as an S-corporation by the IRS. The election to be taxed as an S-corporation must be made within seventy-five days of becoming incorporated or within seventy-five days of the new year. This election takes place when a business files Federal Form 2553. The 2553 Form is an election to have a C-corporation taxed as an S-corporation.
The S-corporation provides liability protection for all the shareholders creating a separation between individuals and the entity. The business is not subject to self employment tax since the reasonable salary paid to employees is subject to FICA taxes and the rest of the distribution is subject to income taxes. The IRS allows shareholders of S-corporations a tax advantage if their business is operating a loss. If the business is running a loss, each shareholder can deduct his or her share of loss on the individual tax return to the extent of their basis. Each shareholder receives a schedule K-1 when the corporate tax return is completed which reports each shareholder’s share of the corporate income or loss and includes the information in his or her individual tax return. The S-corporation reports its gross income, expenses, balance sheet and shareholder information but does not pay corporate income taxes. Depending on the state the S-corporation might not even be subject to state franchise taxes. These are taxes paid to the state for owning and operating a business in the state. States such as Massachusetts, New Jersey, and California can charge more than $400 a year in franchise taxes. However, states such as Georgia North Carolina and South Carolina charge between $10 and $50 for business running a loss. S-corporations present many advantages to business owners entering the corporate environment for the first time and give them the protection professionals need to start a corporation.
There are some drawbacks to having an S-corporation. A proper payroll system must be in place for the business which calculates a reasonable compensation to be documented and paid to officers and shareholders. Secondly, appropriate tax withholdings must be made and tax deposits must be submitted in a timely fashion leaving a small margin for error. Payroll can be complicated so business owners usually hire a professional to keep their books and handle payroll appropriately. Paid professionals will understand state unemployment insurance and will be able to meet quarterly and annual payroll filing requirements. Paying for proper payroll services may be expensive, but having a proper system in place is priceless. Along with a strict payroll system the S-corporation also has strict requirements when it comes to shareholders. The S-corporation can only have up to 100 shareholders and shareholders can only be U.S. citizens, permanent residents, estates, or trusts. This stipulation controls the amount of people involved in the business and the types of entities that can hold shares. The shareholders also must maintain corporate minutes. All decisions made for the business must be properly documented and voted on by the shareholders. The shareholders and officers are obligated to hold annual and quarterly meetings to speak about the direction of the business and can face legal tribulations if the minutes are neglected. The documented minutes are usually sorted through when owners sell shares, claim bankruptcy, dissolve the business, or split up. Minutes are usually hard to keep for shareholders who live in different states or for people who are not organized with their corporate documents. Companies with only one shareholder need to keep minutes as well but these meetings are a lot easier.
The S-corporation can be a good choice for people looking to start small corporations with legal protection and tax benefits for their shareholders. Even though the entity has some drawbacks, it gives individuals the opportunity to succeed in the long run with their dreams. To learn more about the S-corporation and to see if it is the right entity for you, contact the professionals at The Tax Club for a free consultation 888-773-7176.
