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A Complete Overview of S Corporations
A Complete Overview of S Corporations
When choosing a business structure, most entrepreneurs have two goals in mind: protecting personal assets from threats and avoiding business taxes on personal tax returns. Not long ago, S Corporations were the only option for business owners. Most S Corps have recently been replaced with limited liability companies (LLCs). But thanks to the Tax Cuts and Jobs Act (TCJA), S Corps are becoming a top option for business owners.
But how does one know if opting for an S Corporation is right for them? In this guide, you’ll learn everything there is to know about an S Corp, including what is an S Corporation, eligibility requirements, S Corpfiling instructions and the S Corptax rate.
Table of contents
What is an S Corp?
The S Corpdefinition is a type of corporation or legal business entity in the Subchapter S of Chapter 1 of the Internal Revenue Code. Sounds confusing? Let’s break down the S Corpdefinition. An S Corpis an ordinary corporation that has opted for an S Corporation tax status.
You’re eligible for a corporate shareholder’s limited liability when you form an S Corp. Limited liability is a type of legal protection for owners and shareholders and ensures an individual isn’t responsible for a company’s debt or losses. But with an S Corp, you’ll need to pay taxes as if you’re a partner in a partnership or a sole proprietor. This includes paying self-employment taxes.
Let’s look at some S Corporation examples. Say your company has five shareholders, all meeting IRS requirements. Each shareholder holds 20% of the shares.
Or, the company has only two shareholders, one holding 60% of the shares and the other holding 40%. Both shareholders must file their own tax returns relating to the business profits.
Eligibility requirements for S Corps
There are certain requirements a company must meet for a company to qualify as an S Corp. First and foremost, the company must be a U.S. based company. So any plans for an offshore company, sadly, won’t qualify. Next, you’ll need to apply to form an S Corpusing Form 2553. Let’s take a look at Form 2553 S Corp:
You’ll also need to make sure that your business doesn’t have more than 100 shareholders. A shareholder is an individual, company or institution that owns a share of the company’s stock, essentially owning the company. Married couples are treated as one shareholder.
Other eligible shareholders include:
Ineligible shareholders include: nonresident aliens, foreign trusts, limited liability partnerships and limited liability companies with multiple members.
The one class of stock requirement
Usually, companies have a class of shares, which is a type of stock with different voting rights. Corporations with an S status are only allowed to have once class of stock. This means that one class can have voting rights while the other doesn’t, a voting stock and a non-voting stock. This could come in handy if the shareholders are owned by family members and the family members want to give ownership to their children without losing control of the company.
The shareholders with stock in the corporation all get the same amount of dividends or distribution of company profits. If the corporation dissolves or liquidates the business, asset distributions will be given to the shareholders at the same time. Giving out stock to more than 100 shareholders or to ineligible shareholders could put the company at risk of losing its S status.
Number of shareholders
So we’ve already discussed that there can’t be more than 100 shareholders. If they want to have more shares than allowed, the shareholders will need to agree to an amendment showing the change. The exception to this rule is family members can choose to be counted as one shareholder.
A family member is considered someone of lineal descent from a common ancestor, not more than six generations from the youngest family member.
Do S Corps get 1099?
Usually corporations, including S and C corps, do not receive 1099 tax forms. But they are required to send 1099s to all vendors, even corporations.
However, there are some exceptions. You would receive a 1099-MISC if you paid any attorney fees, even for corporations. Or for any gross proceeds paid to an attorney (like settlements for claims) or payments made to medical care providers that are for-profit.
Remember that 1099-MISC forms are only used for services rendered and not for purchasing goods or merchandise. But the services must be related to the business and not for personal use.
Companies would send Form 1099-A to S corporations if they helped sell secure property or Form 1099-B if they bartered exchanges together. They'll send Form 1099-K to S Corps if they made payments of $600 or more using credit or debit cards or third-party payment networks to the corporation for 2022 taxes and beyond. Payments made before 2022 must total at least $20,000 and have at least 200 transactions.
S Corptaxes
Things can get a bit confusing when it comes to S Corporation taxes. S Corps don’t pay federal taxes in a typical way. Instead of paying taxes on their profits, the individual shareholders must pay taxes.
If the corporation pays its employees a salary, it’s responsible for withholding federal taxes, including Medicare and Social Security. Then the company will need to file Form 941 quarterly to fulfill the scorp estimated quarterly taxes requirement.
Form 1120-S reports the company’s income, deduction and payments.
The S Corptax rate is minor and similar to an individual taxpayer. But the S Corptax rate the owner pays is based on the participation of the business owners.
Steps for S Corpfiling federal income taxes:
- Fill out a corporate tax return using form 1120-S.
- Share the profit and loss for each shareholder using the K-1 Schedule.
- Shareholders use the K-1 to file income taxes.
C Corp vs S Corp
Regular corporations, or C Corps, are taxed on business profits, meaning the business itself is taxed. Owners pay taxes on their salary or bonuses. C Corps are essentially taxed twice. The company pays federal income taxes, and shareholders pay taxes through dividends.
On the contrary, an S Corpbusiness doesn't pay taxes, meaning there’s no corporate tax. Instead, the owner reports the company earnings as personal revenue.
The formation of a corporation is different from a C Corp vs S Corp. When a company is formed, it’s automatically considered a C Corp. If you want the S Corpdesignation, you’ll need to apply for this using Form 2553.
When it comes to ownership, C Corps have a lot of freedom, since anyone can be an owner, and you can have unlimited owners. On the other hand, ownership with an S Corpis limited to U.S. citizens with less than 100 company shareholders.
S Corpvs LLC
An LLC, or limited liability company, protects the owner from being held accountable for a company’s debt or losses. LLCs and corporations can be taxed as an S Corporation if they elect that status. An LLC is taxed like a partnership or sole proprietorship. This means, as an owner, you’re considered self-employed and need to file your own local, state and federal taxes, including Social Security and Medicare taxes.
But with S Corptaxes, things are a bit different. If you’re an S Corpowner, you can consider yourself an employee for tax purposes and therefore enroll yourself on the company’s payroll, avoiding self-employment taxes.
LLCs have a lot more freedom when it comes to the number of shareholders since there’s no limit. S Corporations can only have up to 100 shareholders with either individuals or certain trusts as owners. LLCs also don’t face as many regulations as corporations. LLCs can have multiple equity classes, whereas S corporations have the option of a single class of stock.
Depending on your business needs and goals, there are pros and cons to an S Corpvs LLC. Therefore, it's best to weigh out both options before choosing what's best for your business.
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