Incorporation 101: What Is S-Corporation?
What is an S-Corporation?
Incorporation 101: What Is S-Corporation?
It is a quarterly corporation that has 100 shareholders or less and that passes-through net income or losses to its shareholders for tax purposes (similar to sole proprietorship or partnership). Since all corporate income is "passed through" directly to the shareholders who comprise the income on their private tax returns, S-Corporation are not branch to double taxation.
An eligible domestic corporation (C-Corporation) can avoid double taxation (once to the shareholders and again to the corporation) by electing to be treated as an S-Corporation. Generally, an S-Corporation is exempt from federal income tax other than tax on inescapable capital gains and passive income. On their tax returns, the S-Corporation's shareholders comprise their share of the corporation's income or loss.
S-Corporation vs. C-Corporation
Like C-Corporations, S-Corporations are separate legal entities from their shareholders and, under state laws, ordinarily contribute their shareholders with the same liability protection afforded to the shareholders of C-Corporations. Unlike C-Corporations, for Federal income tax purposes taxation of S-Corporations resembles that of partnerships. Thus, income is taxed at the shareholder level and not at the corporate level. Certain penalty taxes (e.g., accumulated income tax, personal retention enterprise tax) and the alternative minimum tax do not apply to an S-Corporation. Unlike a C-Corporation, an S-Corporation is not eligible for a dividends received deduction (a tax deduction received by a corporation on the dividends paid to it by other corporations in which it has an possession stake). Unlike a C-Corporation, an S-Corporation is not branch to the 10% of taxable income limitation applicable to charitable gift deductions.
Who Can Form an S-Corporation?
S-Corporations are more convenient for small and house businesses, and for those who starts their enterprise with small investment. Also, some existing businesses qualify for S-Corporation status.
To form S-Corporation or to turn your existing C-Corporation into S-Corporation (also called "Election of S-Corporation Status") inescapable conditions need to be met:
S-Corporation cannot have more than 100 shareholders. All shareholders must be either U.S. Citizens or residents, estates, or inescapable trusts. Can only have one class of stock. Favorite stock is not allowed. Profits and losses must be accorded to owners in proportion with their possession stake. Must use the calendar year as its fiscal year unless it can demonstrate to the Irs that other fiscal year satisfies a enterprise purpose. Shareholders cannot deduct losses in excess of their investment. The corporation cannot deduct fringe benefits given to employees who own more than 2% of the entity.
S-Corporation Advantages
Forming S-Corporation ordinarily allows you to pass enterprise losses through to your personal income tax return, where you can use it to offset any income that you have from other sources. Shareholders are not branch to self-employment taxes. These taxes, which add up to more than 15% of your income, are used to pay your communal protection and Medicare taxes. When you sell your entity, your taxable gain on the sale of the enterprise can be less than it would have been had you operated the enterprise as a quarterly corporation.
Taxation of S-Corporations
As already mentioned above, S-Corporations are not branch to tax rates. Instead, S-Corporation passes-through behalf (or net losses) to its shareholders and those profits are taxed at private tax rates on each shareholder's Form 1040. The pass-through (sometimes called "flow-through") nature of the income means that the S-Corporation's profits are only taxed once - at the shareholder level. The Irs explains it this way: "On their tax returns, the S-Corporation's shareholders comprise their share of the corporation's separately stated items of income, deduction, loss, and credit, and their share of non-separately stated income or loss".
S-Corporations therefore avoid the so-called "double taxation" of dividends in most states. There are however two exceptions to this rule:
California: There is a franchise tax of 1.5% of net income of an S-Corporation (minimum 0). This is one factor to be taken into observation when choosing in the middle of an Llc and an S-corporation in California. On very profitable enterprises, the Llc franchise tax fees, which are based on gross revenues, may be lower than the 1.5% net income tax. Conversely, on high gross revenue, low profit-margin businesses, the Llc franchise tax fees may exceed the S-Corporation net income tax. New York City: S-Corporations are branch to the full income tax at a 8.85% rate. however if the S-Corporation can demonstrate that a portion of its enterprise was done face the city, that portion will not be branch to the added tax.
Retaining Profits of S-Corporation
S-Corporations are allowed to sustain their net profits as operating capital. However, all profits are considered as if they were distributed to shareholders, and as a effect shareholders might be taxed on income they never received (whereas a shareholder of C-corporation is taxed on dividends only when those dividends are surely paid out).
Converting S-Corp Back to C-Corp
S-Corporation status is not permanent and can be reversed back if so desired. For example, if the enterprise becomes more profitable and there are tax advantages to being a quarterly C-Corporation, S-Corporation registration status can be dropped after a inescapable number of time.
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