One of the most exciting things for a business owner is to see their business operations grow. The only downside to that growth, though, is that more revenue usually leads to higher tax rates.
For smart business practices, the thing to do is to claim “S Corporation” status. By doing this, your profits, losses, and deductions are shared among your partners – and you are taxed at a lower level.
In this post, I’ll explain the benefits of S corporation status and go over the steps for how you can qualify.
I’m a business lawyer for entrepreneurs who’s helped thousands of people realize their dreams of owning and operating their own businesses. I can help you launch yours and show you how to run it as efficiently as possible – so that you’re getting the maximum bang for your buck.
What Does It Mean to be an S Corporation?
Also known as an S subchapter, an S corporation is a specific status recognized by the Internal Revenue Service (IRS).
With it, your business can be taxed as a partnership rather than a corporation.
Here are a few of the other advantages of S corporation status.You’ll pay less in taxes. You’ll only have to yearly, rather than quarterly. You also won’t face double taxation because you’re not paying personal and corporate taxes.
You can attract investors to your company. By offering stock, you’re able to add new partners to your corporation.
You’re protected legally. If your S corporation is sued, your personal interests and assets are protected from debt collectors and attorneys.
You can share profits and put them back into the business. If you and your partners decide, you can treat profits as operating capital or share them.
You can get more and be taxed less. As a partner in an S corporation, you’ll collect a salary as an employee. Bonuses and extras you earn can be enjoyed tax-free.
It’s a great way to attract new business. Having S corporation status gives you instant credibility in the business world. Beyond new partners, it can significantly help with getting new employees, customers, and vendors.
You can easily transfer stock ownership. If you or another partner want to transfer stock for whatever reason, you can do so without having to make adjustments to compliance or other complicated procedures.
What Are the Eligibility Requirements for an S Corporation?
A few legal thresholds must be met to achieve S corporation status.
The business must be a domestic one. Your business must operate here in the U.S., and you and all your partners (if you have any) must sign Form 2553 in a timely manner.
All partners and shareholders must be U.S. citizens or reside in the country (as long as they are a “resident alien”).
You can have no more than 100 partners or shareholders. If your business is a family operation, all family members are considered to be one shareholder. However, everyone else is viewed as individual shareholders.
There’s only one class of stock in your business. Essentially, this means that all shares carry the same rights and values.
Your company is not on the list of ineligible corporations. This list includes:
- Insurance companies taxed under subchapter L of the tax code
- Banks that treat debts under section 585
- Domestic international sales corporations (DISC)
You’ll likely have to update your operating agreement. Before making the transition with the IRS, your operating agreements will need to include language about functioning as an S corporation.
It’s important to know that every business begins as a C corporation. Once that’s taken care of, you’ll then need to file for subchapter S corporation status.
Because filing for S corporation status changes how the IRS views your business, it’s definitely in your best interest to work with a business lawyer such as myself.
Here are a few things to consider before filing for S corporation status.
You may have a few recurring expenses with your state. The rules vary with each state, but some require their S corporation businesses to provide annual reports and pay franchise taxes.
You’ll probably have to adopt a calendar year rather than use a fiscal year. You can satisfy this requirement by
- Selecting a tax year ending Dec. 31
- An ownership tax calendar year
- A 52-53-week tax year
- A natural business year.
The one-class stock could have disadvantages. This can potentially hinder you while attracting new partners or investors. For example, international investors or partners will not be able to come on board.
You’ll likely get more scrutiny from the IRS. While the IRS may begin to take a closer look at payments and expenses, as long as you have your financial house in order, you should be fine. Fringe benefits become taxable.
While you’re able to enjoy bonuses and extras on a tax-free basis with a professional corporation, those become taxable with S corporation status if you own more than 2 percent of the business.
How Do You Form an S Corporation?
The pros of S corporation status far outweigh any potential cons. The money you save in taxes and profit-sharing, coupled with the legal protection you’ll be able to enjoy, make it more than worth the effort.
Whether you’re an individual or part of a group of professionals, setting up an S corporation is the way to go, and I can help you get there.
What To Do Next
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