An S corporation is the most common corporate structure for small businesses. An S corporation is any business that files taxes under Subchapter S of Chapter 1 of the Internal Revenue Code. S corporations can be particularly beneficial to small businesses due primarily to the tax benefits and legal protection afforded to its shareholders.
S Corporation Vs. C Corporation
An S corporation elects to take its profits, losses, deductions and credit and pass them through the shareholders before they are subject to federal taxation. An S Corporation is an incorporation type in which a company can avoid double taxation common to a C corporation. An S corporation is taxed on profits only through the tax returns of its shareholders. This is a huge difference between S and C corporations, as C corporations are taxed before and after the distribution of dividends; i.e., double taxation.
How to File
The IRS will grant a business an S corporation designation if it meets the following requirements:
Benefits of Corporate Status
One of the greatest benefits of corporations in general over a business entity like a sole proprietorship, is in the protections that can be afforded to the shareholders. Whereas a proprietorship has no legal distinction from its owner, corporate shareholders are shielded from unlimited liability by the corporate structure. This means that shareholders cannot be held personally responsible for losses incurred by the S corporation. The S corporation is an entity separate from its shareholders, meaning that only the corporation itself is responsible for paying off its debts.
Further Tax Savings of an S Corporation
Shareholders in S corporations are able to take advantage of a rather opportunistic tax regulation. Since the corporation itself pays not taxes, only the shareholders must make payments on the profits. However, shareholders can spread the profits they receive amongst the members of their families. Since children 13 and under belong to a lower tax bracket than adults, their income will be taxed at a lower rate than parents, thereby saving money overall.
S Corporation Disadvantages
Apart from the restrictions to qualification as an S corporation, small businesses will encounter numerous other hurdles when creating an S corporation. Added expenses for accounting, legal paperwork and payroll processing are often related to the red tape associated with the corporate structure. These added costs can hinder a new business at a time when finances can be at their tightest.
Filing Taxes for an S Corporation
S corporations must file a Schedule K-1 for any person who at any point during the previous tax year was a shareholder. This must be filed with IRS Form 1120S, and a second copy of the Schedule K-1 must then be sent to each shareholder. These S corporation forms must be filed by March 15th.