What is an S Corp? - How to Form an S Corp

What is an S Corp? - How to Form an S Corp
Page content

What is an S Corp?

An S Corp is a corporation that does not pay any income taxes. The business income or loss is passed through the corporation to its shareholders and then the shareholders must report the income on their tax returns. S corps are a special type of corporation many partnerships and sole proprietors use to get limited liability from their businesses.

How to Start an S Corp

Forming an S Corp requires certain qualifications be met. The qualifications are as follows:

  • Must be an eligible entity. Eligible entities are: An LLC or domestic corporation.
  • Must have only one class of stock.
  • Must not have more than 100 shareholders. These shareholders must be citizens of the United States.
  • The profit or loss of the business must be evenly shared among all shareholders based on their interest in the business.

As with starting any other type of business structure, there are certain local, state, and federal guidelines which must be followed. You’ll need to check with your local Small Business Administration to ensure you are in compliance with all the rules and regulations. Consider your business name, your paperwork, your licenses and permits, and don’t forget the IRS. It is best to form an S Corp with the assistance of a lawyer to ensure all parties and the business are legally protected throughout the course of the business.

Advantages of an S Corp

The advantages of an S Corp are as follows:

  • Once an S Corporation is formed, your business structure may change. You do not have to make this a permanent structure if you believe your business needs have changed.
  • The shareholders of an S Corp are not subject to any self-employment taxes. If the shareholders are active LLC owners, the self employment tax still applies, however.
  • If and when you decide to sell your S Corp business, the taxable gain on the sale will be less than if you sold the business as a regular corporation.

Disadvantages of an S Corp

Though there are some excellent benefits associated with choosing an S Corp as a business structure, there are some disadvantages.

  • S Corporations must choose a “permitted tax year.” Generally speaking, they must use the calendar year as their fiscal year, which may present some problems when dealing with governmental contractors.
  • S Corporations cannot deduct the cost of fringe benefits from their taxable income.
  • Depending on the circumstances, some shareholders may be subject to the Alternative Minimum Tax.
  • If there are foreign investors in the company, this business structure will not work due to the citizenship requirement in order to form an S corp.

Photo Credit: MorgueFile

This post is part of the series: Forming Your Business Structure

When starting a new business choosing your business structure is a very important function. This series at Bright Hub will help you learn why is a sole proprietorship a Good Business Structure and help you learn about forming an LLC or forming an S Corp. Read on to find out more about the basics of

  1. Forming Your Business: Choosing Your Business Structure
  2. Sole Proprietorships: The Simplest Business Structure
  3. Forming Your Business: Is a Business Partnership Right for You?
  4. Setting Up a Limited Liability Company
  5. What is an S Corp?