You may have seen the term S-corp floating around from time to time. Whether it be talking about shareholders, taxes, or corporations. You are bound to see this term in the world of business. So let’s break it down and simplify what exactly an S-Corp is.
What Exactly is an S-Corp
The IRS classifies an S Corporation as corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.
C-Corp vs S-Corp, What's the Difference?
Understanding the difference between an S-Corp and a C-Corp can be confusing. Although the two can be identified as corporations, only a C-Corp is recognized as both a legal and tax structure.
S-Corps, on the other hand, are only considered a tax structure. S-Corporations are single-member LLCs, multi-member LLCs, or corporations that make an election to be treated as an S-corporation for tax purposes only. They retain their legal structure (as registered with their state).
S-Corp Taxes, How Do They Work?
As mentioned above, S-Corp shareholders report their profit and loss on their personal income taxes; this is why S-Corps are considered a pass-through entity. The profits and losses pass through to the owners directly.
However, S-Corps are still required to file a tax return with the IRS just like any other business. For S-Corps, Form 1120-S is used to report income, expenses, tax credits, etc., which must be filed every year.
Along with Form 1120-S, owners receive Schedule K-1, which shows their share of the income and equity of the company. Schedule K-1 is needed when it comes time to file your personal taxes.
What Are the Benefits and Disadvantages of an S-Corp?
There are always ups and downs. In this section, we will break down some of the main benefits and disadvantages that apply to S-Corps.
Benefits
No Double Taxation
One of the big benefits that comes with S-Corps is that they don’t have to pay federal tax. Income is instead passed through to the owners, who then must report it on their own personal tax returns. This helps avoid double taxation that C-Corps must pay.
Owners are On Payroll
Owners who actively participate in the business are compensated just like other employees. This also requires owners to have regular payroll checks, just like any other employee of the company.
Health Insurance/Retirement Accounts
Lastly, S-Corp owners can receive health insurance and retirement account benefits. Just like how they can be put on payroll, owners also have access to employee health benefits.
Disadvantages
Although S-Corps have access to some great benefits, potential S-Corp owners must also take notice of the disadvantages that S-Corps bring.
S-Corp Status Can Be Revoked
The biggest disadvantage of an S-Corp is that the IRS can choose to revoke your S-Corp status, along with all of the benefits. Your status can be revoked by exceeding 100 shareholders, having two more classes of stock, or failing to follow the other guidelines set out to be considered an S-Corporation.
File Two Separate Tax returns
While S-Corps don’t pay corporate taxes, they must file Form 1120-S annually. This is a separate tax return for those that were previously taxed as a sole proprietor. They may also be subject to state income or franchise taxes at the S-Corporation level.
How Can I Register My Business As an S-Corp?
For those looking to get started with their own S-Corp, here are the first steps to get you started!
Meet IRS Requirements
According to the IRS, an S-Corp:
- Must be a U.S.-based corporation or LLC.
- Needs to have eligible shareholders
- This can be individuals, certain trusts, and estates.
- These cannot be partnerships, corporations, or non-resident alien shareholders.
- Cannot exceed more than 100 shareholders.
- Can only have one class of stock.
- Cannot be a financial institution, an insurance company, or a domestic international sales corporation.
Filing Form 2553
Once you have met the requirements above, you can fill out and submit Form 2553. This form acts as a request for obtaining S-Corp status. Once it has been approved, your business will be able to be taxed as an S-Corp!
Bottom Line
Unlike C-Corps, S-Corps offer the tax benefits that can help avoid tax expenses. Additionally, owners are able to receive the same benefits that employees may receive, like health and retirement accounts. However, it is important to remember that the S-Corporation must file a separate tax return, as well as keep up with the necessary requirements set by the IRS.
For help in keeping track of your profits and expenses, contact our team at Ledgerfi so you can fully enjoy the benefits that S-Corps offer!
