You have the option to make your Limited Liability Company or LLC into an S corporation with the Internal Revenue Service. However, is it something that you should consider doing or is it another hassle that you have to comply with? Find out here!
What is an S Corp?
S corporations are also called S subchapters. This is a type of legal business entity. S corps derive their name from the fact that they are taxed under the IRS Subchapter S. What makes S corps different from other corporations is that it can pass deductions, credits, incomes, and losses directly to the shareholders without the need to pay federal corporate tax. But, it is liable for specific built-in gains and passive incomes on the corporate level.
Your business must meet certain standards in order for it to qualify as an S corp. These standards include:
- Domestic incorporation
- Only one class of stock
- Number of shareholders is not more than 100
- Have shareholders that satisfy the eligibility requirements.
S corporation shareholders can either be tax-exempt organizations, estates, specific trusts, or individuals. However, they cannot be eligible shareholders if they are nonresident aliens, corporations, or partnerships.
Benefits of S Corp
The following are important advantages that you can get for being classified as an S corp:
- Asset Protection
Sole proprietorship owners can face personal liability if somebody decides to sue the company and succeed. This means that they might have to pay the company’s debt out of their own pock. This is due to the fact that a sole proprietorship does not legally separate the owner from the firm. S corporations, on the other hand, see the owner as a different entity from the firm, implying that the company owns the assets, not the owner. With this, they do not face the risk of exposure in the event of a lawsuit or other financial liabilities.
- Pass-through Taxation
One of the biggest benefits of S corp status is that the company does not need to pay federal tax. Instead, the income of the business passes through the owner hence the name “pass-through” taxation. The shareholder will be taxed based on their part of the profit. They will then need the gains and losses on their personal federal income tax returns. Moreover, S corp shareholders can also take business losses on their own tax returns.
- Simplified Transfer of Ownership
Another excellent benefit of classifying as an S corp is the fact that an owner can transfer their interest without any tax consequences that is usually included when doing this and the company has a partnership or LLC status. Plus, the accounting and taxation rules for the transfer are less complicated compared to other types of corporations.
- Reduced Self-employment Tax
The IRS considers the owners of S corporations to be workers. Because of this, they will pay for self-employment and income tax salaries based on what they get from the company. However, they are not required to pay self-employment tax on the distributions and dividends. This set can have the potential to lessen the overall tax bill of the owner.
The downside of S Corp Status
Just like other things, classifying as an S corp also comes with its share of downsides. This include:
- More Rules to Follow
S corps must comply with rules and regulations that are not followed by sole-proprietorship or LLC. These mostly involved ownership, dividends, stocks, corporate formalities, filing requirements and many more. If these are not complied with, the company risks losing its S corp standing.
- Ongoing Fees
Some states require S corp to pay for annual fees on franchises, reports, and other items. These fees are not really expensive and can be written off as business expenses but they are additional overhead costs.
- More IRS Scrutiny
It is an established fact for the IRS that companies choose to qualify for S corp status to lessen their tax liabilities. With this in mind, they pay extra attention to these companies to ensure that they comply thoroughly with the law.
When Should You Decide to Classify as an S Corp?
Sure, there are plenty of benefits in choosing to get an S corp status. However, it’s not for everybody but, it can help minimize your tax payments if your business has the following circumstances:
- Satisfy S corp restrictions
- Earns a minimum of $10,000 in distribution yearly or enough net profit to pay a reasonable salary to owners.
- Will have reasonable tax savings to make up for the accounting and payroll cost associated with an S corp election.
If your business falls under all or any of the following circumstances, then opting to classify as an S corp is worth considering. However, if it is not, then you might be better off as an LLC or sole proprietorship.
The nice thing about S corp classification is the fact that it can help save money, especially in terms of tax. However, it is not applicable to all businesses out there. This is why it’s important to assess your business first whether it’s the best step to take moving forward.
If you’re hesitant and don’t think you have the expertise to decide whether or not to file for S corporation status, you might want to get advice from an accountant. You can also choose online incorporation services, which are available at nominal recurring cost. They will do the hard work of assessing your financial status and determining whether you will be able to save or lose money if you decide to go for an S corp status.