If you are considering forming a business entity, you may be wondering “what is an S corp?” An S corporation is a regular corporation that meets certain criteria specified by the Internal Revenue Code and elects a special election under Subchapter S of the Internal Revenue Code. An S corp is a pass-through entity. If the corporation qualifies under the S subchapter, income is passed directly to the shareholders without having to pay corporate-level federal taxes on the profit. S corp status allows a business to have the same advantages of incorporation while enjoying the flow-through taxation of a partnership.
How to Set up an S Corp
An S corp is not a business structure unique from a Limited Liability Company or a Corporation — it is an IRS tax designation that can be used to change a Corporation from a separate taxpayer to a flow-through entity. Either a corporation or a Limited Liability Company can be an S corp. In order to obtain tax treatment under subchapter S, you must first form an entity then elect S corp status through Form 2553.
To qualify and maintain S corp status, an entity must meet the following requirements:
- Have only one class of stock
- Have 100 shareholders or fewer
- Shareholders must be U.S. citizens or have permanent residency status
- Be registered as a domestic entity
- All shareholders must agree to S corp status
Unlike a corporation which is taxed in the regular course of business under Subchapter C, C-Corp corporate tax is not imposed on an S corp. Rather, each stockholder is responsible for paying taxes on the corporation’s profits.
Advantages of Setting up an S Corp
There are numerous advantages to forming an S corp. Operating as an S corp has several crucial tax benefits, despite close scrutiny by the IRS. S-corps enjoy flow-through taxation. S-corp shareholders are entitled to draw salaries, as well as receive dividends and other distributions.
What are the Disadvantages of an S Corp?
Significantly, mistakes made regarding filing requirements, stock ownership, or any aspects of S corp formation or maintenance of S-corp requirements can result in the termination of S corp status. There is also less flexibility concerning the allocation of income and losses due to the fact that S corps are only permitted one class of stock.
While there are many tax advantages to forming an S corp, the arrangement can also bring several critical disadvantages. For example, unlike with a C corporation, the income of each S corp shareholder is taxed — regardless of whether it is reinvested or distributed to the shareholders. The IRS also requires S corps to pay reasonable salaries to all shareholders, even if no profit has been made.
Contact an Experienced New York Business Attorney to Learn More
If you are forming a new business and want to learn more about what is an S corp, it’s integral to have a business attorney on your side who can provide strategic guidance and insight. Brinen & Associates has extensive experience counseling clients regarding the appropriate form of entity and preparing the necessary documents to help ensure the success of your company. Call (212) 330-8151 or send us a message to learn how we can help.