S corporations are corporations that chose to pass their corporate income, losses, deductions, and credits through to their shareholders. S corporations report their flow-through income and losses on their tax returns.
Certain corporations choose to be treated as S corporations for Federal tax purposes. One major reason is that the S election allows companies to avoid double taxation, where income is taxed at both the corporate and level and personal level. C corporations are taxed at both the corporate and individual levels.
S Corps are favored by many business owners. Their single taxation and limited liability protection make them an attractive choice. You can also consider starting with an S corporation if you think you’d go public in the future but want initial losses to flow through. You can convert to a C status after you have taken advantage of flowing through losses.
Qualifying for S Corp Status
An S corporation has the tightest restrictions on ownership among all entities. For example, only 100 or fewer shareholders are allowed for an S corporation and non-US residents are not allowed to form S corporations.
The Advantages of an S Corporation
Tax professionals suggest the S status for a number of advantages, such as the following:
Limited liability protection. Limited liability means you can’t be financially responsible for more than your investment in the company.
Separate entities. S corporations are still considered separate legal entities, which means that the owner has limited liability for corporate debts.
20% QBI deduction. The Tax Cuts and Jobs Act of 2017 gave eligible S corporation shareholders a deduction of up to 20% of net “qualified business income”.
Flow-through taxation. Profit is distributed among shareholders who are in turn taxes at the personal level.
Tax-favorable characterization of income. S corporation shareholders can be employees of the business and draw salaries as an employee, as well as receive dividends.
Save on self-employment taxes. Owners of an S corporation are not considered to be self-employed, so they pay no self-employment tax at the distribution portion.
Disadvantages
An S corporation is not for everyone. There are also disadvantages that those considering the status should watch out for:
Stock restrictions. S Corporations are limited to one class of stock.
Higher income, higher taxes. Because of the flow-through setup, high-income shareholders will pay more taxes.
Only 100 shareholders. S corporations are not allowed to have more than 100 shareholders.
Cannot hold over 2% of shares. Owners or employees holding 2% or more of company shares cannot receive non-taxable benefits.
Termination of status. Although rare, the S corporation status can be terminated on account of violations of rules governing the status.
Need Help with Your S Corporation Taxes?
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