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What is an S Corporation?
An S Corporation is a type of business organization formed under the guidelines of Title 26, Subchapter S of the U.S. Internal Revenue Code. Legally, the organization is considered a separate entity, which is one of many advantages to S Corporations. In simple terms, an S Corporation is a blend between a corporate structure and a general partnership. The organization is formed by tax election with the IRS and formal incorporation with the Secretary of State where the organization will be headquartered. The owners become shareholders in the organization, with a board of directors. To qualify for incorporating as an S Corporation, the organization must meet guidelines determined by the IRS.
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As a separate entity, one of the advantages to S Corporations is the protection of shareholders from business debts and torts. Legally, an S Corporation is an artificial person, separate from its owners (shareholders.) Therefore, if the business were to become bankrupt, shareholders would not be held personally liable for business debts. Likewise, if the organization were to become involved in a tort (liability) suit during the course of normal business, shareholders’ personal assets cannot be attached as part of any settlement. The protection from financial liability is an appealing advantage for many small business owners. The organization can function as its own person, owning property, incurring debts, and assuming liability for its own actions and financial commitments.
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In terms of tax benefits, an S Corporation pays no corporate income tax. Instead, as with a general partnership, income is passed through to shareholders. This presents a great advantage in that owners can avoid double taxation. In a standard corporation, the organization must pay taxes on its income. When dividends are paid to shareholders or stockholders, these individuals must pay personal income tax on monies received as personal income. With an S Corporation, since no corporate income taxes are imposed, owners merely report their share of earnings on their personal tax return and pay income taxes accordingly.
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For individual S Corporation owners, there are personal advantages to S Corporations. Not only can these shareholders enjoy peace of mind due to decreased liability and protection of personal assets, they also have an easier time filing taxes. Since many S Corporations are small business owners with only two or three shareholders, filing corporate taxes as well as personal tax returns would be a daunting task. Owners would have to hire an accountant or struggle through complicated corporate returns themselves. With an S Corporation, owners simply report their share of company earnings on their personal returns like any other income. For some business owners, the idea of less paperwork and fewer headaches is advantage enough to consider incorporating as an S Corporation.
As with any major business decision, be sure you know all the facts. While there are many advantages to S Corporations, there are some drawbacks. The IRS has specific requirements for record keeping, continued qualification for S Corporation status, and other guidelines to consider. Carefully weigh the options available and education yourself on topics such as the differences between an S and a C Corporation. Consult with an accounting professional, business attorney, or other expert before making a final decision.
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References and Resources
Cornell University Law School, US Internal Revenue Code, Title 26, Subchapter S http://www.law.cornell.edu/uscode/26/usc_sup_01_26_10_A_20_1_30_S.html
Georgia Secretary of State, Which Legal Entity is Right for Your Business? http://sos.georgia.gov/corporations/legal_entity.pdf
Horngren, C, Harrison, W, & Smith, L. (2005). Accounting. Upper Saddle River, NJ: Pearson Education.
IRS, S Corporations http://www.irs.gov/businesses/small/article/0,,id=98263,00.html
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