S Corp Requirements (What You Shouldn’t Forget Before Forming!)

If you’re looking to start an S Corporation, you should understand the requirements of starting an S Corp.

You have a business idea swimming in your head you want to pursue. Great…

If you’ve never established and managed a business before you are quickly going to discover there are a lot of steps to take before you can just run with that business idea of yours.

For most, S Corporation is the best business type if you’re a self-employed entrepreneur.

With an S Corporation, you would be able to avoid self-employment tax which save you usually around 15.3% of your income. If you have a business that generates a nice profit over and above what you would consider reasonable compensation for the services that the owners provide, you may be unnecessarily subjecting the profits to self employment taxes if you are operating as an LLC taxed as a partnership.

Wondering what an S Corp is and what requirements there are for your business to form as an S Corp?

For example. S Corp can’t have more than 100 shareholders and all shareholders must be U.S. residents.

If you have any other questions and you’re looking to form an S Corp, email me sam@mollaeilaw.com

As an experienced business lawyer, I’m as familiar with business structuring as I am with the back of my hand.

 

What is an S Corporation?

An S corporation is a sweet spot between a C corporation and a partnership. S Corp allows you to side step the double taxation issue you would face if you structured your business as a C Corp instead.

Your business profit, loss, deductions, and credit all pass through your shareholders when you operate as an S Corp.

S-Corporation is a special type of corporation that will SIGNIFICANTLY save you money on your taxes by allowing you to avoid paying self-employment taxes.

By becoming an employee of your own S-Corporation, you take a salary, then the rest of the pass-through income is no longer subject to self-employment tax and you avoid corporate tax on your salary.

By having an S-Corporation, you also protect your personal assets from business debts, claims and lawsuits. What this means is that if something happens to your business then your personal assets such as your personal bank account, home, car, and personal investments will be protected.

The first thing most successful entrepreneurs do is form a S-Corporation. I HIGHLY recommend forming your S-Corporation before you start your business.

 

S Corp Benefits

In an S-Corporation, only earnings paid to an owner as salary is subject to payroll taxes. Any money left in the business for reinvestment or distributed to the shareholder as a dividend is not subject to self-employment tax.

Here is a scenario that seems to help clarify things:

Maria is a sole proprietor bringing in sales of $90,000. After she pays her costs & expenses, her profit is $60,000. As a sole proprietor, she is required to pay self- employment tax of 15.3% on this entire $60K of profit, which equates to $9,180.

Now, let’s assume Maria formed an S-Corporation for her business, and chooses to pay herself $35K for the year in salary, and take the remaining $25K of profit through a distribution. She still earns the same $60K in profit. But, let’s look at the tax situation. Because corporations only pay Social Security & Medicare taxes on salaries, she’s only liable for $5,355, saving over $3,800 in taxes.

 

S Corp Requirements

For the IRS to recognize your business as an S Corp, your business must meet the following 8 requirements:

1. Your business must be a domestic corporation.
2. You cannot have over 100 shareholders. You do have the option of classifying spouses as single shareholders.
3. Each shareholder must be an individual, estate, trust, tax exempt organization, or other S corporation. A shareholder cannot be a partnership or a C corporation.
4. The corporation cannot have any nonresident alien shareholders.
5. It has only a single class of stock.
6. Your corporation is not an ineligible corporation such as an insurance company or financial institute.
7. It will adopt a natural business year.
8. It has obtained the content of each shareholder.

 

How the IRS Can Revoke Your S Corporation Status

Your corporation must continue to meet these eight requirements after the S election is approved by the IRS.

For example, your corporation cannot admit over 100 shareholders after being approved as an S Corp. Nor can the corporation accept nonresident shareholders.

If you fail to maintain the requirements established by the IRS to operate as an S Corp, your business will automatically shift to and be taxed as a C corporation.

 

How to Become an S Corp

To establish your business as an S corporation you must submit the Form 2553 Election by a Small Business Corporation. You must have the form signed by each shareholder.

You must file Form 2553 within the first two months and fifteen days of the beginning of the tax year in which the election is to take effect. If you file it later, your election will be effective for the next tax year.

You can also file the form at any time during the tax year before the year in which the election is to take effect. You can file at any time after these deadlines if your corporation follows special rules for making a late S-corporation election.

Just email me at sam@mollaeilaw.com and I can help you with the paperwork.

 

Should You Structure Your Business as an S Corp?

S Corp is great for self-employed entrepreneur. The income of an S corporation generally is taxed to the shareholders of the corporation rather than to the corporation itself.

An S corporation is an eligible domestic corporation that avoids double taxation (once to the shareholders and again to the corporation) by electing this status using Form 2553 (Election by a Small Business Corporation).

Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income.

 

Benefits of S Corp

Arguably the biggest upside to S Corp status is no corporate tax. You can also benefit from reduced tax gains by selling the business when you retire.

With any business, there are a lot of expenses. It is not uncommon to endure more losses than profits when you set things up.

As an S Corp, you can write off those losses against your personal income. If you were a C Corp, you couldn’t do that.

An S corporation status will also provide you with some protection against liabilities. Just remember a lot of lenders now require guarantees.

So, S Corp won’t offer full protection.

 

Disadvantage of S Corp

If you are interested in going public, S corporation may not be the right status for you as you can only have one class of stock.

Establishing as an S Corp can also make it harder to get investors as an S corporation doesn’t offer the same appeal as a C Corp.

While you do get to avoid double taxation, you still must file a tax return every year.

A corporation is a corporation whether you structure as an S Corp or a C Corp. As such, you still must have regular meetings and maintain meeting minutes.

It is common for small business owners to opt to structure as an LLC because it is easier to manage than a S Corp. What is right for you really boils down to how much administrative time you have on your hands.

Formalities Difficulties of S Corp

1. Bookkeeping and accounting
2. Payroll (i.e. ADP, Intuit, Paychex, Zen Payroll) – you need to remit taxes through a payroll system
3. Legal formalities (Bylaws, etc)

 

Social Security Benefits Reduced For S Corp

• Social Security eligibility requires: earn 4 credits a year, around $1,300 minimum earnings, benefits eligible at 40 credits, all 4 earned at once, around 10 years of work required.
• Benefit amount: percentage of earnings, based on income, progressively reduces for wealth, 35-year average used, timing to full retirement age key
• Social Security determined by S-Corporation Salary. Reducing your salary to save in self-employment taxes will reduce your social security benefits.
•  Solution: save and invest tax savings while growing your business (perhaps use vanguard.com for index funds)

 

Lowered Mortgages and Retirement Contributions For S Corp

• IRA & 401k contributions limits determined by salary. 401k contribution types: employer or employee. Employer = a match or profit share contribution. Profit share: up to 25% of Salary or Schedule C.
• Buying a house: determined by Salary, not dividend. Mortgages for business owners: usually need 2 years of income. Remember, you’re saving thousands in self-employment taxes. Lowered salary = lower approval amount. Pay higher interest for special lending options.

 

What To DO Next

For someone who has decided a corporation is a better structure for their business than an LLC, an S corporation is a great way to avoid some of the downsides that come with structuring as a C corporation.

Don’t struggle with the paperwork alone when you can contact an experienced business lawyer such as myself at sam@mollaeilaw.com for assistance.

I can make sure you meet the requirements to form as an S Corp and help you with the necessary paperwork.