S CORPORATION FAQ
An S-corporation in the USA is a closely held corporation that makes a valid election of being taxed under the Subchapter S of Chapter 1 of the Internal Revenue Code. Basically, unlike the C-Corporation, the S-Corporation does not have to pay any corporate income taxes.
What is an S Corporation?
An S-Corporation refers to a type of corporation that meets specific Internal Revenue Code requirements. It is also known as an S subchapter. The requirements offer corporations with 100 shareholders or less the benefit of the incorporation while being taxed as a partnership. In addition to this, it also has to be a domestic corporation where it can have only eligible shareholders and have only one class of stock. This means that the corporation has the right to pass income directly to the shareholders and avoid double taxation that the C-corporation suffers from.
To explain better, the corporation taxes filed under the Subchapter S may pass the business income, losses, deductions, and credits to shareholders. Shareholders report the losses and income on the individual tax returns, and pay taxes at ordinary tax rates. S corporations pay tax on specific built-in gains and passive income at the corporate level.
Additionally, the shareholders in the S-corporation have to be individuals, estates and specific trusts, or certain tax-exempt organizations (501(c)(3)). Corporations, partnerships and nonresident aliens are not qualified as shareholders for an S-Corporation. Along with this, the domestic international sales companies, insurance companies, and specific financial institutions are also not qualified.
What are the main benefits of forming S Corporation?
There are a lot of things that need to be considered when forming a business entity. An S-Corporation has a lot of benefits that would make you want to choose it as an option for your company. Here are the main benefits that you enjoy by forming an S-Corporation:
- Unlimited management personnel with no state residency requirements
- Limited liability for shareholders and management
- Good privacy protection, especially if you decide to open the s-corp in Wyoming and Nevada.
- Flow-through taxation – the profits are distributed to the shareholders who are then taxed on the profits on their personal income tax return.
- Distinct and court-recognized existence helps protect you from personal liability that can cause you to lose all the personal wealth that you have including your nest egg, car, and/or home.
- Great income-splitting potential for employees/owners. The owners can take a small salary and pay income taxes and regular payroll deductions. Then, the remainder of the profit can be taken as a distribution which would be subjected to income tax only.
S-Corporations are great for the businesses that:
- will not have significant start-up costs
- will provide a service
- will not need to make major equipment purchases before the starting of any operation
- will make a sizable amount of money without a great deal of effort and expense
What is the purpose of Form 2553?
The moment a business owner decides to register their small business as a corporation with the IRS, they are incorporated as a C-Corporation by default. That is when businesses can file the IRS form 2553, which is also called the Election by a Small Business Corporation and elect to form an S-corporation instead of a C-Corporation. The form 2553 permits the small business to register as an S-Corporation rather than a C-corporation.
This comes with the significant tax benefits that can save your company money during the tax season. S-Corporations are not subjected to the double taxation that the C-corporation suffers from. The S-corporation taxation method is very similar to that of a limited liability company (LLC) or a partnership. In short, by filing Form 2553, you are reducing your tax liability. So, instead of paying up to 35% of corporate tax, the form turns your company into a “pass-through company” for tax purposes. That is where the income tax is taxed to its shareholders, not to the corporation itself.
How S corp is taxed?
S-Corporation is taxed very differently from the C-corporation. To begin with, the C-corporation files its annual return using the Form 1120S, unlike the C-corporation that uses 1120 for filing its annual return. Moreover, the 1120S is an informational return that simply informs the federal tax authorities of the amount of net profits or losses accrued by the company. And about the proportion by which the profits or losses are to be distributed to the shareholders.
Just to be clear, there is no tax payment or refund associated with the 1120S tax return as the S-Corporation does not have the independent tax status that a C-Corporation has. Instead, the losses or profits are considered and distributed to the shareholders in the proportion to the ownership interest of the shareholders.