What is an S-Corporation?

It is a regular corporation that has 100 shareholders or less and that transfers net profit or loss to its shareholders for tax purposes (similar to sole proprietorship or partnership). Since all corporate income is “passed on” directly to shareholders who include the income on their individual tax returns, S-Corporations are not subject to double taxation.

An eligible national corporation (C Corporation) can avoid double taxation (once for shareholders and again for the corporation) by electing to be treated as an S Corporation. Generally, an S-Corporation is exempt from federal income tax that does not be the tax on certain capital gains and passive income. S-Corporation shareholders include their share of the corporation’s income or losses on their tax returns.

S Corporation vs. Corporation C

• Like C corporations, S corporations are separate legal entities from their shareholders and, under state law, generally provide their shareholders with the same liability protection that is provided to shareholders of C corporations.
• Unlike C corporations, for federal income tax purposes, S corporation taxes resemble those of partnerships. Therefore, income is taxed at the shareholder level and not at the corporate level.
• Certain penalty taxes (eg, retained earnings tax, personal holding company tax) and the alternative minimum tax do not apply to an S-Corporation.
• Unlike a C corporation, an S corporation is not eligible for a deduction for dividends received (a tax deduction received by a corporation on dividends paid to it by other corporations in which it has an ownership interest).
• Unlike a C-Corporation, an S-Corporation is not subject to the 10% taxable income limitation applicable to charitable contribution deductions.

Who can form an S corporation?

S corporations are best suited for small and family businesses, and for those who start their business with a small investment. Additionally, some existing companies qualify for S-Corporation status.

To form S-Corporation or change your existing C-Corporation into S-Corporation (also called “Election of S-Corporation Status”), certain conditions must be met:

• S-Corporation cannot have more than 100 shareholders.
• All shareholders must be citizens or residents of the US, Estates or certain trusts.
• You can only have one class of stock. Preferred shares are not allowed.
• Gains and losses must be awarded to owners in proportion to their share of the property.
• You should use the calendar year as your tax year unless you can show the IRS that another tax year serves a business purpose.
• Shareholders cannot deduct losses in excess of their investment.
• The corporation cannot deduct fringe benefits granted to employees who own more than 2% of the entity.

S-Corporation Advantages

• Forming S-Corporation generally allows you to transfer business losses to your personal income tax return, where you can use it to offset any income you have from other sources.
• Shareholders are not subject to self-employment tax. These taxes, which add up to more than 15% of your income, are used to pay your Social Security and Medicare taxes.
• When you sell your entity, your taxable profit on the sale of the business may be less than it would have been if you had operated the business as a regular corporation.

Taxation of Public Limited Companies

As already mentioned above, S corporations are not subject to tax rates. Instead, S-Corporation transfers the gains (or net losses) to its shareholders and those gains are taxed at the individual tax rates on each shareholder’s Form 1040. The pass-through (sometimes called “direct flow”) nature of income means that the S-Corporation’s profits are only taxed once – at the shareholder level. The IRS explains it this way: “On their tax returns, S-Corporation shareholders include their share of the corporation’s separately reported income, deduction, loss, and credit, and their share of non-income or loss. declared separately “.

Therefore, S corporations avoid the so-called “double taxation” of dividends in most states. However, there are two exceptions to this rule:

• California: There is a franchise tax of 1.5% of the net income of an S-Corporation (minimum $ 800). This is a factor to consider when choosing between an LLC and an S corporation in California. In highly profitable businesses, LLC franchise tax rates, which are based on gross income, can be lower than the 1.5% net income tax. In contrast, in businesses with high gross income and low profit margin, LLC franchise tax rates may exceed S-Corporation’s net income tax.
• New York: S corporations are subject to full income tax at a rate of 8.85%. However, if the S-Corporation can show that a portion of its business was conducted out of town, that portion will not be subject to the additional tax.

S-Corporation Withholding of Benefits

S corporations can retain their net earnings as working capital. However, all profits are treated as if they were distributed to shareholders and as a result, shareholders could be subject to taxes on income they never received (whereas a shareholder of a C corporation pays taxes on dividends only when those dividends are actually paid).

Conversion of S-Corp back to C-Corp

S-Corporation status is not permanent and can be reversed if desired. For example, if the business becomes more profitable and there are tax advantages to being a regular C Corporation, the S Corporation registration status may be removed after a certain period of time.