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Choosing to Incorporate as an S Corporation

An "S" corporation is a company that forms as a C corporation and then chooses special tax status that makes it a "pass-through" entity, like an LLC. And S corporations' profits and losses can be passed directly to the owners without first being taxed at the corporate level, because, unlike a C corp., an S corp is not a separate taxable entity. Thus, choosing S status eliminates the double taxation issue faced by owners and shareholders of C corps.

To become an S corporation, you must first file as a regular C corporation, as the articles of incorporation you file with the state are the same for both the C and S corporations. Once the state in which you're incorporating sends you back your paperwork, you fill out an IRS form 2553 ("Election by a Small Business Corporation) and send it in to the IRS.

What Are the Benefits of Electing S Corporation Status?

Electing S corp status confers a number of benefits. These include:

  • Corporate profits pass through directly to owners without being taxed at the corporate level.

  • As with a C corporation, an S corp is said to have a lower risk of being audited by the government than other pass-through business forms, such as sole proprietorship or LLCs.

  • Owners, directors and employees are protected from liability for the liabilities, obligations and debts the business incurs: In a number of states, this limited liability applies even if only one individual owns all the stock in the S corporation, and acts as its only employee.

  • Owners can use the corporation's losses to offset income.

  • They also can lower employment taxes by taking distributions rather than salary.
  • What Are the Negatives of Electing S Corporation Status?

  • Although similar in many ways to other pass-through entities, such as LLCs, S corp status requires more paperwork and more formalities, such as filing a yearly informal return that indicates earnings, losses and how much of each belongs to each partner in the corporation.

  • Income must be allocated to owners according to their ownership interests.

  • A number of states levy a minimal (usually 1% to 2% of profits) Franchise Tax on S Corporations; this is not so for LLCs.

  • S corps are not allowed to provide as many fringe benefits as a C Corporation.

  • Unlike C corps, S corporations cannot have unlimited shareholders; 100 is the maximum number of shareholders allowed.

  • Although owners can deduct business losses against other income, an active owner can only do so the extent of their loans to or investment in the S corporation.
  • What Documents Do I Need to Form an S Corporation?

    You'll need the same documents as for a C corporation (articles of incorporation, bylaws, organizational board resolutions, stocks certificates and a stock ledger), PLUS one more: the IRS form 2553 ("Election by a Small Business Corporation). As mentioned above, this is filed with the federal government after you receive back the other documents of incorporation from the state.

    Want more information about registering a company? Visit our Guide. Check out incorporation fees by each state.

    Tip: Did you know that Delaware and Nevada are top two incorporation states?

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