New business owners looking to replace their previous “corporate” income, or those who want their business stick around for the foreseeable future: listen up. You need to educate yourself on the option of electing to be taxed as an S-Corporation.
First off, to clarify, an S-Corp merely indicates how an entity is taxed. It’s not a business “structure”, per se. On the other hand, an LLC is an actual business entity- meaning, it provides legal separation of your liability from your business. An LLC can elect to be taxed as a S-Corp by filing a form 2553 with the IRS within the statutorily allotted time.
LLCs are (generally speaking) the most flexible, easy-to-manage type of formation. LLCs may have simple tax requirements, such as allowing income to flow through on a personal return, avoiding double taxation. On the other hand, other corporate structures, such as C-Corporations must file corporate tax returns, so owners can only derive income through corporate distributions or a W-2 salary. S-Corporations, on the other hand, allows the taxation of the company to be similar to a partnership or sole proprietor as opposed to paying taxes based on a corporate tax structure
Therefore, the question of whether or not an S-Corporation will work for you will come down to a question of taxes– when will you be making enough money to get enough tax breaks to warrant electing S-Corp status? A word to the wise: if your business makes an income and you anticipate it being around for some time (ie, more than the next few months), you need to talk to a lawyer or accountant about forming an S-Corp.
There are pros and cons with any formation structure, but here is a general overview of S-Corporations:
- There are certain retirement/restructuring advantages to this form. Note: a five-year statute of limitation applies to many business succession plans I work on you must be aware of. But when done correctly, an S corporation could have reduced taxable gains when the business is sold. This is one reason why it’s so important to work with a tax/legal professional when starting your business,
- Taxation: there are no corporate taxes. The profits and losses of the business pass through to the corporation owner’s personal income tax. Like a Limited Liability Company, the tax “pass-through” allows you to avoid “double taxation”.
- Potential start-up write-off opportunities
- Limited liability protection, similar to that of an LLC
- Shareholders can be individuals, estates, and certain trusts.
- May be harder to attract outside investors
- You must file a tax return annually
- More corporate formalities: you must conduct regular meetings and maintain company minutes
- No more than 75 shareholders
- Shareholders must be U.S. Citizens
- The company must be domestic (U.S.)
- One class of stock: Choosing an S Corporation status will limit your organization to issuing one class of stock, which may affect your business’ control on an internal level.
Making the decision about what business entity is right for you is an incredibly important decision and not one that should be taken lightly. If you’re a member of my email list, you received access to this graph this week breaking down the differences between each of the formation options available, if not click here to get the full chart.