Basic Explanation of an S-Corporation
An S-Corporation sometimes causes confusion as to whether it actually qualifies as a traditionally identified business entity. A person could split hairs arguing both sides, but what is important to recognize is that a business registers with their state as their chosen business structure (check your state law for requirements). But to become an S-Corp, a business must file with the IRS.
An S-Corp is a corporation, including qualifying Limited Liability Corporations (LLCs), that meets certain qualifications, laid out by the IRS, to be taxed differently than other types of business entities.
To be classified as an S-Corp, a business has to fill out an IRS Form 2553, meet very specific criteria, and be approved by the IRS.
So, if someone says their company is an S-Corp, what they actually mean is that their company is a domestic corporation that meets the IRS requirements to be taxed as an S-Corp.
The requirements, per the IRS, are:
- Be a domestic corporation (be incorporated)
- Have only allowable shareholders
- May be individuals, certain trusts, and estates
- May not be partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).
The main reason businesses file as an S-Corporation are the tax benefits. The primary benefit is avoiding double taxation, earnings being taxed first at the corporate level, then at the individual income tax level for any dividends the company pays to shareholders. An S-Corp elects to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. The shareholders report these “pass through” areas on their personal income tax returns and are taxed at their applicable income tax rate. Basically, this allows the S-Corp to avoid paying taxes at a corporate level.
Not all states are equal in how they tax S-Corporations. Some tax the same as the federal government, some tax the same as a regular corporation, and everything in between. So check with your state to understand how your state taxes S-Corps.
There are other advantages to filing to become an S-Corp, as well as some disadvantages, but hopefully this will give you an idea whether you should continue to consider filing as an S-Corporation.