Establishing a business requires you to decide the type of company structure you want. This can be tedious and time-consuming. S Corporation is one structure you have the option of, but it is important to know what it is and how it can benefit your business.
S Corps, also known as S subchapters or S Corps, are businesses that have been elected to S Corps by the IRS. They must meet specific requirements of the Internal Revenue Code, such as:
Being incorporated domestically within the US
Not more than 100 shareholders that meet certain eligibility criteria.
Only one stock class.
S Corps status grants business incorporation benefits while also receiving tax-exempt benefits of partnerships and sole-proprietorships. There are many benefits to running an S Corps:
Liability Protection
Your personal assets are kept separate from the business assets when you run an S Corps. This gives you protection from the business’s liability since suppliers and lenders can’t seize your personal assets to pay off loans or debts.
You are also protected against losses that the business may incur because they are stored within the company. However, liability protection is not complete protection. You can still be sued if you cause harm to another person or business.
Tax Benefits
S Corps are pass through entities and don’t have to pay the same taxes as other corporations. Pass-through taxation allows a business to pass its profits or revenue to shareholders as dividends, or salary. However, they must not exceed the stock basis of the shareholder.
Capital gains are usually taxed on dividends that exceed the stock basis. The tax paid is less than that implied by ordinary income.
This will allow you to reduce self-employment taxes, which partnerships and sole proprietorships pay large amounts of. It also helps you save money in the long term. When calculating the income that you will pass on to shareholders, you can also subtract the salaries paid.
Straightforward Ownership Transfer
Transferring more than 50% of an LLC or partnership can lead to the entity’s termination. Even if the shares are transferred in acceptable amounts, shareholders can still be subject to negative tax consequences.
S Corps does not allow shareholders to adjust the property basis or transfer interests without having to comply with complicated accounting regulations or face extreme tax responsibilities.
It’s easy to convert if your business grows and meets all the requirements of a typical corporation. You just need to file the IRS for the conversion election.
This is not the case for converting an LLC to an S/C corporation. In that case, business owners must adhere to the LLC and state corporations laws. Also, you will need to file certain documents with the state.
Cash Basis Accounting Method
Unless they are small corporations, most corporations use accrual accounting. Small corporations typically have gross receipts below $5,000,000. S Corps, on the other hand uses the cash basis accounting method.
The accrual accounting method recognizes revenues and expenses when they occur. However, in the cash-based accounting method they recognize both when there is a transfer of funds. The accrual method doesn’t track cash flow so you may not be able to recognize cash shortages in the short-term, which could lead to losses later.
S Corps can track cash flow in real time, and identify any shortages immediately. This improves the chances that the organization can correct its mistakes and stay in business.
Higher Credibility
The formal commitment to the business is what makes the application for S Corp status public. This will make it easier to build trust among employees, customers and partners. This will help you increase sales and give you a competitive edge.
Conclusion
Scorps can help you reduce self-employment taxes by allowing you pass on the profits and revenues of your business as salaries and dividends to shareholders. This allows you to protect your personal assets and make it easier for you to own and convert the business.
Although an S Corp offers many advantages over partnerships, corporations, sole proprietorships, and other entities, the application process for opening a business can take as much time as any other. You should research the requirements and qualifications for your state. They might be different from one state to another.
You will need to choose a name for your business, appoint your board of directors and file incorporation articles.
